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COPYRIGHT DEPOSIT. 



PRINCIPLES OF 
COST ACCOUNTING 



BY 

JOHN R. WILDMAN, M.C.S., CP.A. 

PROFESSOR OF ACCOUNTING IN THE NEW YORK UNIVERSITY, 
SCHOOL OF COMMERCE, ACCOUNTS AND FINANCE 



1914 

NEW YORK UNIVERSITY PRESS 

WASHINGTON SQUARE EAST 

NEW YORK 



■ C?W63 



COPTRIGHT, 1911, BY 
JOHN R. WILDMAN 






JUN 30 1916 



The WOKam G. Hewitt Press 

Brooklyn, New York 



^>CI,A438956 



PREFACE 

The motive which prompted the author to prepare and 
publish Cost Accounting, was the desire to supply a demand 
for a text book on the part oi the students in New York 
University School of Commerce, Accounts and Finance. In 
presenting it for public consideration it is desired to have 
clearly understood the fact that it is intended as a text book 
especially adapted to the needs of students, and is not in- 
tended as a general reference work. 

The supply of literature on the subject of cost account- 
ing is increasing rapidly. The quality of such literature is 
of a high order. The fault to be found with it from the 
point of view of a teacher is that it is too highly specialized. 
The tendency on the part of authors on this subject is to 
select some particular industry or line of production and 
describe a particular system, attempting to make such typical 
of the entire subject. 

Most systems are accompanied by elaborate forms. In 
fact it may be said that many systems are nothing more than 
a collection of forms. This practice has been carried to 
such an extent that it would not be extravagant to state that 
the average student looks upon the study of cost accounting 
as a matter of becoming familiar with certain specific forms 
comprising a particular system. In this maze of forms the 
student becomes lost and the principles underlying the forms 
are entirely overlooked. 

During the first few years of the author's experience in 
accounting work he devoted a great deal of time to collect- 
in 



Preface 

ing forms of all kinds, especially those having to do with 
cost accounting. After having collected enough to half fill 
a medium sized steamer trunk he discontinued the practice. 
There were two reasons why. Being always so busy col- 
lecting them he never had time to refer to them. When he 
had occasion to devise and use a form he constructed it 
anew without reference to his collection. Having deter- 
mined the subject for which the form was needed and 
considering the use to which it was to be put, it was only 
necessary to make the form, through its construction and 
arrangement, call for the information desired. Experience 
taught him that a knowledge of what the form should recite 
was of vastly more value than familiarity with any particu- 
lar form, or than to be able to refer to a splendid collection. 
Little attention has been given to forms in the prepara- 
tion of this book. It is essentially a book setting forth the 
principles of cost accounting rather than a treatment of the 
subject in all its refinements. To the experienced cost ac- 
countant it will be of little value. To the engineer dealing 
with cost accounting problems it will be of less value. To 
the student, whether in the technical school of some univer- 
sity, or in the works department of a plant in some small 
manufacturing town, it is hoped that this book may give a 
broader conception of the subject, impress the principles un- 
derlying it firmly upon his mind, and so prepare him that he 
mey attack intelligently and successfully the problems which 
confront him and read and study to better advantage some 
of the more interesting literature now available and being 
prepared by specialists in this line of work. 

John Raymond Wildman. 
New York, 
June 4, 19 10. 

IV 



CONTENTS 



CHAPTER PAGE 

I.— Objects in Ascertaining Cost -. I 

II. — Classification of Costs 5 

III. — Selection of a System 9 

IV. — Accounting Cost System 12 

V. — Manufacturing or Factory Cost System .... 18 

VI. — Orders 26 

VII.— Materials and Supplies , . .31 

VIII.— Labor 37 

IX.— Overhead 44 

X. — Types of Manufacturing Cost Systems .... 50 
XI. — When Departmental Distribution of Overhead is Indi- 
cated 54 

XII. — Defective Goods, Waste, Shrinkage and Idle Time . . 58 

XIII. — Distributable Overhead and Bases of Distribution . . 63 

XIV.— Machine Rates 67 

XV. — Wage Systems 71 

XVI. — Fixing of Wage Rates 79 

XVII. — The Efficiency Department . . . . . .81 

XVIII. — Reconciling Predetermined and Estimated Costs with 

Actual Costs 88 

XIX. — Report of the Cost Department 93 



Principles of Cost Accounting 

CHAPTER I 

The Objects in Ascertaining Cost 

A discussion of the subject of Cost Accounting involves 
the consideration of three topics: 

( i ) The nature of the information being sought. 

(2) The means of obtaining the information. 

(3) The use to which the information is to be put, after 
it is obtained. 

A consideration of the first topic requires an inquiry into 
the objects in ascertaining costs. Briefly stated they are as 
follows : 

(a) To ascertain whether or not a business undertaking 
is profitable. 

(b) To serve as a basis for fixing selling prices. 

(c) To furnish information to the proprietor or admin- 
istrative officer which will guide him in forming his adminis^ 
trative judgment. 

In the simplest of business transactions the interesting 
element is that of profit. A man who undertakes a business 
venture of any kind is primarily interested in knowing 
whether he is making or losing money. In either case, how 
much? He is secondarily interested in knowing whether his 
business is sufficiently profitable. By this is meant, whether 
or not the return on the investment is up to the average for 
the line of business in which he is engaged. 

I 



Principles of Cost Accounting 

If he is engaged in trading, his first or gross profit is 
from the sale of his merchandise. In order to ascertain his 
profit he must oppose against the proceeds of his sales the 
cost thereof. If his cost is incorrect, his profit is incorrect. 
Strangely enough, the error in such cases is usually against 
him rather than in his favor. Such errors frequently re- 
peated are inclined to lead him suddenly, and often to his 
surprise, into a condition of insolvency. Hence the import- 
ance, even in the simplest transactions, of having informa- 
tion on the subject of cost which is correct and trustworthy. 

Competition as it exists today calls for the greatest of 
care in fixing selling prices. The exercise of such care re- 
quires business experience, a knowledge of business condi- 
tions and reliable information concerning costs. The suc- 
cessful contractor is the man who not only gets the contract 
by virtue of having submitted the lowest reasonable bid, 
other things being equal, but the man who can get his profit 
out of the contract after he has succeeded in securing it. 

If a loss results, or the margin of profit is too small, it 
means, upon repetition, one of two things must be done; 
either the selling price must be increased, or the cost must 
be decreased. 

Of these two expedients, the first is usually inadvisable, 
if not impossible, without resulting in a loss of business, and 
the business man looks to the second means for relief. Can 
he use this means intelligently if he is not absolutely sure of 
his cost? Obviously, not! 

Through the aid of accurate information concerning 
costs the proprietor or administrative officer is enabled to 
keep in close touch with conditions, shape the operating 
policy of the future and guide the operations as they mature. 

He is enabled: 

2 



The Objects in Ascertaining Cost 

a. To determine which lines of production or merchan- 
dise are profitable and which are unprofitable; to institute 
methods for extending and increasing the sale of such lines 
as are profitable and to retard the sale of, or withdraw en- 
tirely from the manufacture, or sale of, such lines as are 
unprofitable ; to decide intelligently the lines on which com- 
missions may be allowed to salesmen and the extent of such 
commissions. 

b. To reduce costs; either through a reduction of the ele- 
ments composing costs, or through an increase in the pro- 
duction. 

c. To allocate "leaks" and stop unnecessary waste or ex- 
travagance. 

d. To develop the highest type of productive efficiency. 
To bolster up the weak points and harmonize the work of 
the different departments, or operating groups. 

e. To gauge the efficiency of managers, relatively speak- 
ing, by comparing one manager with another. The man- 
ager, whose cost of producing soil pipe per ton is $7.00, is 
obviously not as efficient or capable as the man who under 
precisely similar conditions can produce the same product at 
a cost of $5.00 per ton. 

/. To compare the work of similar foremen, depart- 
ments, machines, operatives, or other centers of production. 

g. To compare costs in general of one period with an- 
other. 

h. To compare actual costs with estimated or predeter- 
mined costs. The tendency today is toward standardization. 
Generally speaking from the standpoint of costs, standards 
are unattainable. A comparison of actual costs with stand- 
ard costs determines the percentage of efficiency. 

Modern business organization has become so complex 

3 



Principles of Cost Accounting 

as to have passed beyond the limits of individual observa- 
tion, unless the individual has some artificial means of tran- 
scending these limits. The time has passed when the admin- 
istrative officer can be in touch with all the details of the 
business. Cost statistics offer such a man a means of tran- 
scending his individual limits. They afford him an opportu- 
nity of having placed before him at stated intervals a picture, 
as it were, of his business operations. The administrative 
officer, or proprietor, draws his conclusions from the pic- 
ture, and is afforded thereby a basis on which to found his 
judgment as to future operations and policies. It is said of 
the late Mr. Harriman, that he owed his success in a meas- 
ure to his ability to interpret the operations of his many 
business enterprises from the statistical reports which he re- 
quired of his representatives from time to time. 



CHAPTER II 

Classification of Costs 

Costs are frequently referred to without distinction as 
to whether manufacturing or selling costs are meant. That 
such a distinction should be made is important. Manufactur- 
ing cost, as will be seen in the classification appearing below, 
contemplates only such costs as arise, in the factory, in con- 
nection with the manufacture of the product. Selling cost 
has as its basis the manufacturing cost, to which is added the 
expense of selling the product, the expense of administration, 
and all other items of expense incident to the conduct of the 
business. The trader, who buys and sells merchandise, tech- 
nically speaking, has no manufacturing cost. His is a selling 
cost, having as a basis, however, an item of cost of purchase, 
corresponding relatively to the cost of manufacture. 

The details of each class of costs are as follows : 

1. Manufacturing costs, composed of 

Prime cost and 

Manufacturing overhead, variously referred to as 
Factory loading 
" burden 
" expense 
indirect 
Manufacturing expense 
"Oncost." 

2. Selling costs, the elements of which are 

(a) Manufacturing cost 
5 



Principles of Cost Accounting 

[(b) Selling expense 

(c) Administrative expense 

(d) Fixed charges or capital expenses 

(e) Provisions for reserves 
(/) Deductions from sales. 

A somewhat more detailed analysis of selling costs 
would include the following items : 
A. Manufacturing cost 

1. Prime cost 

(a) Materials and supplies, including 

inward freight and cartage, and duty 

(b) Labor — direct — such as . 

"cutting out " and "stitching" in the 
manufacture of shoes. 

2. Manufacturing overhead 

(a) Labor — indirect 

Foremen 

Helpers (not working on product) 

Porters 

Watchmen 

Messengers 

Teamsters 

(b) General factory expense 

Heat, light and power 
Shop supplies (so small as not to war- 
rant charging to stock) 
Repairs and renewals 
Office supplies 
Office expenses 

(c) Salaries 

Manager or superintendent 
Clerks — keeping factory records 
6 



Classification of Costs 

(d) Depreciation of machinery and tools, or 
other operating equipment 

B. Selling expense 

(i) Salesmen 

Salaries 

Traveling expense 

Commissions 
(2) Advertising 

C. Administrative expense 

(1) Salaries 

Officers 

Clerks — keeping general records 

(2) Expense — general office 

Printing and stationery 

Postage 

Telephone and telegraph 

Traveling — officers and clerks 

Legal 

Miscellaneous 

D. Expenses of capital — (subject to offset on account of 

other income) 

(1) Cash discount on sales 

(2) Rent 

(3) Taxes 

(4) Insurance 

(5) Interest 

E. Provisions for reserves 

( 1 ) Defective goods returned 

(2) Doubtful accounts 
(3) Depreciation of plant 

F. Deductions from sales 

( 1 ) Allowances 

7 



Principles of Cost Accounting 

(a) Loss 

(b) Breakage 

(c) Damage 

(2) Trade discounts 

(3) Rebates 

(4) Outward freight 

The above outline is intended to be indicative rather 
than exhaustive. 

The relation of selling cost to selling price, the elements 
of which are cost and profit, may be made apparent by the 
following illustration: 

SELLING PRICE 



I Deductions from Sales 



Provisions for Reserves 



I Expenses of Capital 



Profit I Administrative Expense 



I Selling Expense 



I Manufacturing Overhead 



I Prime Cost 



8 



CHAPTER III 

The Selection of a System 

Having determined the nature and extent of the infor- 
mation sought, the question of how it is to be obtained 
arises. What kind of accounting mechanism, or system, 
shall be employed for this purpose? 

Product differs. What will serve in one case may not 
serve in another. Hence in order to decide intelligently as 
to the means to be employed in obtaining the required in- 
formation it will be necessary to study the question of pro- 
duction with regard to the type of product and try to dis- 
cover certain characteristics common to the various types. 

If a baker were to mix up a batch of dough, consisting 
of flour, eggs, milk, sugar, butter, baking powder, salt and 
flavoring, roll it out on a board and cut crullers therefrom, 
each ring of dough would contain the same quantity of in- 
gredients and have resulted from the same operations of 
labor. All having come from the same batch of dough, there 
could be no dissimilarity in the quality of the ingredients. 

If it were desired to find the cost per dozen crullers, the 
cost of the ingredients, the labor and any expense like lard 
for frying, and heat, would be combined and the amount 
divided by the number of dozen crullers resulting from the 
batch. This process may be repeated indefinitely and the 
result will always be the same, subject to fluctuation in the 
cost of the elements, namely, an average cost per unit. The 
unit will have remained the same throughout and the elements 

9 



Principles of Cost Accounting 

which the unit represents will likewise have remained the 
same. The operations will have been confined to the pro- 
duction of a single thing of a certain grade. Hence the term 
single unit production may be used to describe this and simi- 
lar situations. By single unit production is meant that class 
of production in which the units produced are identical with 
regard to the kind, quantity and quality of material used, 
require the same operations of labor and share equally in 
the distribution of the overhead. Single unit production is 
always attended by a uniform cost per unit and as a rule 
by a uniform sales price. 

If a manufacturer were engaged in producing steamer 
trunks, wardrobe trunks and sample trunks for salesmen, 
it is doubtful if any one having to fix the sales prices 
would take the average cost price of a collective batch 
of these trunks. True, they are all trunks, but they 
are sufficiently unlike to make it necessary to consider 
their cost separately. The wardrobe trunk and sample trunk 
are larger than the steamer trunk and contain much more 
material. The wardrobe trunk is more extensively fitted 
while the sample trunk is strongly built and reinforced in 
order to withstand the severe and almost constant handling 
to which it is subjected. Thus it will be seen that not only 
does the material differ but the peculiarities of the different 
trunks call for operations of labor which vary in their char- 
acter and extent. These variations affect the distribution of 
the overhead in the various cases and the result, if properly 
obtained, is cost on what might be said to be three classes of 
product. The dissimilarity is almost as marked as if the 
manufacturer were producing trunks, traveling bags and 
umbrellas. 

In the latter case no one would question the statement 

10 



The Selection of a System 

that there were three classes of units. With equal facility it 
should be seen that the situation is the same in the former 
case. The units are all trunks, but they may be so entirely 
different with regard to the kind, quantity and quality of 
material and the operations of labor that they may be consid- 
ered as units differing entirely in their nature. 

To describe such a situation, where the manufacture is 
confined to one article but the article varies in size, quantity 
or quality of material, or operations of labor, or where the 
manufacture extends to different classes of articles, the term 
multiple unit production may be used. Multiple unit pro- 
duction is attended by various unit costs and various sales 
prices. 

Production, then, as used in its relation to cost, may be 
classified as: 

Single unit 
Multiple unit 

The selection of the system to be employed in securing 
the desired information concerning the cost will depend 
upon the kind of production involved. 

Where the elements of cost may be thrown together and 
divided by the number of units produced, because one unit 
is, for practical cost purposes, like every other unit, one 
system, very simple in its character, will suffice. Where the 
elements of cost must be grouped in accordance with the 
segregation of units before division may be made, a different 
system, and one far more complicated, is indicated. 

The systems available for use, and which will be de- 
scribed in detail in subsequent chapters, are as follows: 
The accounting cost system 
The manufacturing (or factory) cost system 



ii 



CHAPTER IV 

The Accounting Cost System 

The accounting cost system is the simpler of the two, in 
that it involves no books other than those usually embraced 
in the system of financial accounts. For this reason the ac- 
counting cost system is sometimes referred to as a "finan- 
cial" cost system. It contemplates a complete and compre- 
hensive classification of operating accounts in the general 
ledger such as were shown in the outline covering the ele- 
ments of selling cost. The arrangement of the accounts is 
somewhat changed, however, in order that the financial oper- 
ations may be clearly brought out and the source of profits 
allocated in preparing statements from the books. The 
asset and liability accounts appear in the general ledger as 
usual and the trial balance of same furnishes the information 
necessary to prepare the balance sheet and statement of 
income and profit and loss. It is essential that the latter 
should be tied into the balance sheet in order to prove its 
mathematical correctness, and it is the statement which be- 
comes the basis of the cost sheet. 

In addition to the work contemplated by the ordinary 
system of accounting it is necessary that a record should be 
kept of the units sold and the units returned in order that 
the net sales in units may be ascertained. If the cost of net 
sales is obtained and the number of net units sold is known, 
it is obvious that by dividing cost by units an average cost 
per unit may be obtained. It is true of course that the cost 

12 



The Accounting Cost System 

may be slightly inaccurate on account of not selling in every 
case the physical units produced during the period, but if 
the units are of the same type the objection to the discrep- 
ancy will be so slight as to be almost nil when compared 
with the saving in time and expense; which the use of the 
system accomplishes. 

It will be seen from the following statement of income 
and profit and loss that the accounting cost system may be 
adapted to single unit production and afford to the adminis- 
trative officer an excellent picture of the operation of the 
business and a basis for administrative judgment. General 
captions have been principally used here in order to con- 
dense the statement, but it should be understood that in 
practice the statement should embody all the detail, accounts 
as set forth in the analysis of selling costs. 



13 



Principles of Cost Accounting 



STATEMENT OF INCOME AND PROFIT AND 
PERIOD ENDED 


LOSS F( 


3R THE 






Units 


Money 
Values 


Cost Statistics 
Average per Unit 


Gross sales 












Less returns 








Net sales 
















Deduction from sales : 
Trade discounts 












Allowances : 
Breakage 




Damage 




Loss 




Outward freight and cartage 




Total 
















Income from sales 
















Cost of sales (deduct) : 
Materials and supplies consumed 
Labor — Direct 












Manufacturing overhead 

Difference in inventory of goods 
in process 




Difference in inventory of finished 
goods 








Total 
















Gross profit on sales 
















Selling expense (deduct) 
















Selling profit 
















Administrative expense (deduct).. 












Net profit on sales — Income from 
operation 












Other income (add) 








Total Income 
















Deductions from income 
















Net income — profit and loss 












Profit and loss credits (add) 












Total 
















Profit and loss charges (deduct).. 












Profit and loss surplus for the period 

Profit and loss surplus — beginning 

of period (add) 
















Profit and loss surplus (per balance 
sheet 

















14 



The Accounting Cost System 

In connection with the preceding statement, a discussion 
may be had with advantage of the second section, or that 
dealing with the cost of sales. It is important that the rela- 
tion between the items making up the cost of sales, as shown 
in the statement, and the same items, as they are found in 
the subsidiary records, should be clearly established. The 
materials and supplies shown in the statement, are the ma- 
terials and supplies consumed in the manufacture of the 
product. The figure representing consumption is arrived 
at by starting with the inventory of materials and supplies 
on hand at the beginning of the period, adding thereto the 
purchases during the period, and deducting from the total 
of such amounts, the inventory on hand at the end of the 
period. The consumption of materials and supplies, to- 
gether with the direct labor and manufacturing overhead for 
the period, passes over theoretically into the account repre- 
senting goods in process. The consumption might have been 
arrived at by applying to the purchases the difference be- 
tween the inventory at the beginning, and the inventory at 
the end of the period. If the inventory at the end of the 
period is greater than at the beginning of the period, ob- 
viously, all materials and supplies purchased have not been 
consumed and the purchases are subject to a decrease on 
account of the increase in the inventory. Where conditions 
are the reverse, the purchases are subject to increase on 
account of the decrease in the inventories, for the reason 
that more materials and supplies have been consumed during 
the period than were purchased. 

The cost of the goods in process which during the period 
have been completed and transferred to finished goods, is 
arrived at step by step, through the following accounting 
processes. To the value of the inventory of goods in process 

15 



Principles of Cost Accounting 

at the beginning of the period, there is added an amount 
combining the materials and supplies consumed, the direct 
labor expended, and the manufacturing overhead. From 
the total of these amounts there is deducted the value of the 
inventory of goods in process on hand at the end of the 
period. The result obtained by these processes gives the 
value of the goods which have been finished and transferred 
to stock during the period. The same result might have 
been obtained by applying to the combined values of mate- 
rials and supplies consumed, direct labor, and manufacturing 
overhead, collectively, the increase or decrease in the inven- 
tories of goods in process, at the beginning and at the end 
of the period, respectively. 

The cost of the goods sold is obtained from the treat- 
ment of the finished goods account in a manner similar to 
the preceding; namely, adding to the inventory of finished 
goods on hand at the beginning of the period the value of 
the goods transferred to finished stock during the period, 
and deducting from the total of such values the inventory of 
finished goods on hand at the end of the period. The prin- 
ciple of applying to the value of the goods transferred dur- 
ing the period the increase or decrease in the inventories of 
finished goods may be carried out as well with this account 
as with the materials and supplies and the goods in process 
accounts. 

From the foregoing, the thoughtful reader will doubtless 
have reached the conclusion that the same result may be 
arrived at, by treating the items involved in the cost of manu- 
facture during the period with the increases and decreases in 
the inventories of both goods in process and finished goods. 
If to the purchases, after having been treated with the dif- 
ference in inventories of materials and supplies, there is 

16 



The Accounting Cost System 

added the cost of direct labor and the manufacturing over- 
head and the total of such three items is then affected by the 
difference in inventories of the goods in process and the fin- 
ished goods, the result will be precisely the same as that 
obtained by going through the accounts step by step and 
following each operation. A careful study of the following 
tabulations will undoubtedly serve to bring out the thoughts 
which the above remarks intend to convey. 





Materials 

and 
Supplies. 


Labor 
Direct. 


Manufac- 
turing 
Overhead. 


Goods In 
Process. 


Finished 
Goods. 


Inventory at beginning of 
period 


$4,000 
10,000 






$15,000 
l6,00O 


$17,000 
19,000 


Purchases 












Total 


14,000 
6,000 


31,000 
12,000 


36,0OO 
9,000 


Inventory at end of period . . 






$6,000 


$2,000 


Consumption 


$8,000 


$19,000 


$27,000 








$16,000 







Presented in the form of a statement the figures appear as follows! 

Purchases $10,000 

Deduct Increase in Inventory Materials and Supplies 2,000 

Consumption $8,000 

Labor — Direct 6,000 

Manufacturing Overhead 2,000 

Total $16,000 

Add — Decrease in Inventory Goods in Process 3,000 

Add — Decrease in Inventory Finished Goods 8,000 

Cost of Goods Sold $27,000 



17 



CHAPTER V 
The Manufacturing or Factory Cost System 

Where multiple unit production is involved, the ques- 
tion of system becomes much more complex. More details 
are required, and consequently a more elaborate set of 
books. General books and general accounts are entirely 
adequate in the case of single unit production, but it is im- 
practicable, if not absolutely impossible, to obtain the neces- 
sary results in the case of multiple unit production. The 
accounting cost system answers the purpose so long as noth- 
ing beyond average costs is required, but it should be pointed 
out that the application of this system might result disas- 
trously if the identity of the various units were overlooked 
and average costs obtained. An average cost would be en- 
tirely satisfactory if accompanied by average sales; that is 
to say, if an equal amount of sales in each of the lines was 
made. The average cost of three (3) lines of production 
at $14, $15, and $16, respectively, might be $15, and no 
damage could result if there were a corresponding average 
sale of the three (3) lines. An increase in the demand for 
goods costing $16 and a decrease in the demand for those 
costing $14 would materially alter the situation, and the 
manufacturer, having at his disposal only the information 
that the average cost of his three (3) lines of product was 
$15, might be unable to account for the condition of insol- 
vency which would very likely fall upon him. 

In the use of the manufacturing cost system, it is neces- 

18 



The Manufacturing of Factory Cost System 

sary to distribute or apply the material and supplies, labor, 
and overhead over the various grades or units of production, 
and keep special cost records. It is necessary to determine 
the cost of each grade, or quality of product. Each lot, or 
unit, or group of small units, must be identified, usually by 
number, and each traced through the process of manufac- 
ture, the items of cost accumulating as the work progresses. 

The proprietor is primarily concerned with a cost upon 
which to base a selling price, but he may also desire infor- 
mation of a statistical nature, which will enable him to gauge 
or compare the efficiency of the management, or the opera- 
tives in some particular division of the work. 

There are three (3) elements making up the cost: 
Materials and supplies; 
Labor; 
Overheard; 

Manufacturing, 
General. 

The next question is, how to arrange the system so as to 
furnish the information as to how much of each element 
goes into the cost of the various units in process of manufac- 
ture? 

It is usually conceded that a departmental organization 
furnishes the best form for accomplishing these results ; not 
necessarily a physical division or department, but at least 
a division so far as the recording of the operations is con- 
cerned. By placing each department under the charge of 
some employe, a distribution of the supervision of the work 
and records is accomplished without complicating the ac- 
counting mechanism and working a hardship upon one, or a 
small number of employes. 

While the matter of classifying manufacturing cost sys- 

19 



Principles of Cost Accounting 

terns, with regard to the various types involved, will be taken 
up later, the author desires to confine his remarks at the 
present time to a discussion of the simple type, wherein in- 
formation having to do with materials and supplies, and 
labor, is obtained by the cost clerk direct from each depart- 
ment, instead of allowing the cost to accumulate on depart- 
mental records as the work progresses. 

The work in process is identified by a system of num- 
bers, under which each department reports the charges for 
material and supplies, and the labor which it has against 
these numbers. Where it can be avoided the overhead 
should not be allowed to become involved in departmental 
records. It is only necessary to complicate the work of the 
departments by loading them with overhead, where statistics 
for administrative purposes are required for the purpose 
of judging or comparing the efficiency of a supervising oper- 
ative, or foreman, a group of operatives, or the work of a 
department, and such distribution is not contemplated in the 
simple type of system. If indicated by special circumstances 
the records covering such distribution should be made sub- 
sidiary to the general cost records, and no department bur- 
dened with any overhead, which does not originate there, or 
fall under the responsibility or control of the head of the 
department. The value of statistics for administrative use 
is destroyed when, for example, an attempt is made to judge 
the efficiency of a manufacturing department by such items 
as salaries of officers, traveling expenses of officers, or any 
similar item not specifically affecting same. 

Let it be remembered then, that the departments are to 
report the charges which they have against the work in pro- 
cess to the cost department, which should provide a book in 
which these reports may be summarized. 

20 



The Manufacturing of Factory Cost System 

The stores department should be required to furnish a 
record of the materials and supplies issued, showing the 
number of the jobs or lots against which they are issued. 
This department should keep a detailed record of the cost 
of the materials and supplies, the receipts and issues of 
which should be summarized in the materials and supplies 
ledger. 

Labor departments report to the cost department the 
charges for direct labor against the work in process, and 
these are summarized to show the distribution over the jobs 
in process, and ultimately the total direct labor charge 
against each job. The items of materials and supplies, and 
labor constitute the direct charges. 

Overhead comes from the accounting department, and 
is allocated to the work in process through the medium of 
a distribution sheet, showing both the manufacturing and 
general overhead. 

The results of the charges for 
Materials and supplies; 
Direct labor; 
Overhead; 

Manufacturing; 
General, 
are summarized and carried in the cost ledger until the job 
is completed. At such time they are transferred to a finished 
goods ledger. 

From the above it will be seen that the books required in 
the manufacturing cost system are three (3) , namely: 
Materials and Supplies Ledger; 
Cost Ledger; 
Finished Goods Ledger. 
Specimen pages of these books with transactions which 

21 



Principles of Cost Accounting 

may be traced from the various reports will be found on 
pages 23, 24 and 25. 

The reports referred to are three in number, as follows: 
Materials and Supplies — from stores department — 

see page 23. 
Direct Labor — from operating departments — see 

page 24. 
Overhead — from accounting department — see page 

25- 
It should be noted that the three books comprising a part of 
the manufacturing cost system are controlled by accounts in 
the general ledger with which they should be in agreement. 
The connection between the books, reports, and the work 
as it passes through the factory, may be made somewhat 
clearer by the following illustration : 




DIRECT LABOR 



OVERHEAD 



COST LEDGER 



FINISHED GOODS 
LEDGER 



22 



The Manufacturing of Factory Cost System 



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23 



Principles of Cost Accounting 



SPECIMEN PAGE— COST LEDGER 

Lot Number 280 

Put in Process Dec. 15-22. Completed Dec. 21-28 

Dozens 1224 Quality #4 Cost per Dozen $16.073341 



Date 


Total 


Materials 

and 
Supplies 


Labor 


Manufact- 
uring 
Overhead 


Overhead 
General 


Date 

Transferred 

to Stock 


1908 
Dec. 10 


$7,311.28 


$7,311.28 










" 10 


924.23 




$924.23 








u l7 


1,540.39 




1,540.39 








" 24 


2,464.62 




2,464.62 








" 31 


1,232.33 




1,232.33 








" 31 


6,200.98 






$1,347.31 


$4,853.61 






$19,673.77 


$7,311.28 


$6,161.57 


$1,347.31 


$4,853.61 


Dec. 31/08 

. 































24 



The Manufacturing of Factory Cost System 



SPECIMEN PAGE— FINISHED GOODS LEDGER 

Quality #4 

Production Sales 



Date 


No. 
Lot 


No. 

of 

Doz. 


Cost 

Per 

Dozen 


Amount 


Date 


Inv. 

No. 


No. 

of 

Doz. 


Cost 

Per 

Dozen 


Amount 


1908 
Nov. 30 


268 


742 


$17.32 


$12,851.44 


1909 

Jan. 3 


73 


1000 
742 


| 

$17.32 $12,851.44 


Dec. 31 


280 


1224 


*16.07 


19,673.77 




. 


258 


* 16.07 


4,146.92 


































































































































































'$16.073341 



as 



CHAPTER VI 

Orders 

Before passing on to the detailed discussion of the ele- 
ments comprising cost and the methods of handling same, 
some attention should be given to the system of orders 
which is used for controlling the operation of the plant and 
the goods in process. 

It is customary to allow no material to be used and no 
labor to be expended without an order. These orders origi- 
nate in the factory office, are prepared by the order clerk, 
or some of the office-help, and are always authorized by the 
manager or superintendent, or someone designated by the 
manager with the authority to give the order; never by the 
workmen. 

Orders are divided into three classes, which, together 
with their uses, are shown by the following: 

1. Plant: 

(a) Extensions. 

(b) Equipment. 

(c) Repairs and maintenance. 

2. Production: 

(a) Stock, sometimes called standing orders. 

(b) Special, specifications accompanying. 
[(c) Stock repair. 

1. Goods damaged before shipment. 

2. Goods returned by customers. 

(a) Repaired at plant's expense. 

(b) Repaired at customer's ex- 

pense. 

3. Shipping: 

26 



Orders 

It may not seem within the province of a discussion of 
cost accounting to include under the head of orders, plant 
extensions, equipment, repairs and maintenance. As a tech- 
nical matter it is not, since cost accounting implies such ac- 
counting in connection with the product manufactured. The 
material and labor incident to work on the plant are often so 
intimately associated with such items entering into the prod- 
uct and the principle governing their control so identical, 
however, that it does not seem amiss to include such orders 
in the general scheme for control. 

Materials and supplies intended for plant use will as a 
rule be, or should be, put under the control of the stores 
department and should not be issued without the proper 
order. 

Labor on plant may be performed by some of the oper- 
ating force or by a special staff consisting of carpenters, ma- 
chinists, etc., engaged for such purpose. In either case the 
orderly and systematic record of the work requires that an 
order for same, properly describing and identifying it, shall 
be issued. 

The illustration which follows is intended to cover the 
essential features of such an order without attempt at polish. 



m 



Principles of Cost Accounting 

EMPIRE HAT MANUFACTURING COMPANY 

f Extensions. w 

Plant Order: i Equipment. 

t Maintenance and repairs. Date 



SUPERINTENDENT OR FOREMAN: 

You are hereby instructed to proceed with the following described 
work; to draw on the stores department for the necessary materials and 
supplies and to charge all labor expended in connection with the work to 
the above order number. 



DESCRIPTION OF WORK 



Work to Begin 

Work to be Completed 



Manager, 



ISSUED IN QUADRUPLICATE: 

i. Office or order department. 

a. Factory. 

3. Stores department. 

4. Cost department. 

The plan of manufacturing differs with different concerns 
and in accordance with the peculiarities of the different lines 
of business. Some concerns manufacture for stock, regard- 
less of whether or not sales orders have been received, while 
others begin the work of producing on special orders only 
after sales orders have been received. Other concerns do 
both. 

The practice will depend entirely on the experience of 
the manufacturer as to which plan shall be followed. On 
staple articles, where orders are large, numerous, and 
steady, manufacturing for stock will usually be found, since 

28 



Orders 

special orders would delay shipment beyond a reasonable 

time. In lines of business where styles play an important 

part and are inclined to change frequently and quickly it 

would be taking more than the average risk to produce any 

considerable amount of stock in advance. 

A great variety of production order forms will be found 

in practice, framed to fit the needs of the particular cases, 

but in principle they are represented by the following: 

EMPIRE HAT MANUFACTURING COMPANY 

fStock. No 

Production Order: ^ Special. Date 

t Stock repairs. 



SUPERINTENDENT OR FOREMAN: 

You are hereby instructed to proceed with the production of the follow- 
ing described articles; to draw on the stores department for the necessary 
materials and supplies and to charge all labor expended on same to the above 
order number. 



Work to Begin 

Give Original Order Number 

In Case of Stock Repairs. Manager. 

ISSUED IN QUADRUPLICATE: 

i. Office or order department. 

2. Factory. 

3. Stores department. 

4. Cost department. 

The principle underlying shipping orders is that all fin- 
ished goods shall be in the custody of the stock clerk or the 
shipping clerk and that nothing shall be shipped without an 
order. The shipping order, when completed by the shipping 
clerk, with his notation to the effect that the goods have 
been shipped, is returned to the factory or general office and 
becomes the basis for preparing the sales invoice which is 
sent to the customer. 

29 



Principles of Cost Accounting 

Provision is sometimes made for connecting the shipping 
order with the sales invoice by a manifold process. The 
shipping order, which is a partially completed carbon copy 
of the sales invoice, is supplemented after being taken from 
the billing machine with such information as is needed by the 
shipping clerk but does not concern the customer. This 
scheme where practicable has the advantage of reducing 
clerical labor somewhat. 

The illustration which follows shows a combination 
shipping order and sales invoice. The two carbon copies 
which go to the shipping clerk, one of which he returns 
while retaining the other for his files, contain all the infor- 
mation shown on the face of the invoice except the price and 
amount. These are prevented from being copied on the 
carbons by shields. 



Date Jan. 10, 1908 



John C. Brett and Company, 
712 7th Ave., Pittsburgh, Pa. 



TO EMPIRE HAT MANUFACTURING COMPANY, 
32 Waverly Place, New York 



Invoice No. 1 
Shipping Order No. 1 
Ship at once — prepaid 
Via American Express 



Pack 3 Doz. to the Case 
Label J. C. B. & Co. 



Date 



1908 
Jan. 9 



Qual. 



4xlw 
olw 



Style 



Bos. Derby 
Stetson 2 



Color 



Brown 
Black 



Doz. 



Price 



$16.50 
14.00 



Less — Discount 10% 

Net 
_J 



Amount 



$198.00 
84.00 



$282.00 
28.20 



$253.80 



SIZES 



6M m 7 7 T A 7'A 



30 



CHAPTER VII 

Materials and Supplies 

Under this heading four things should be considered: 
First : A place to keep them. 

Second: The records employed by the stores depart- 
ment. 
Third: The system used by the stores department. 
Fourth : Reports issued by the stores department. 
With regard to their location and custody it is of course 
necessary that they shall be under the immediate supervision 
of some one individual who will be responsible for their 
safety and preservation. Such an individual should be pro- 
vided with the proper means of safeguarding the materials 
and supplies, as it is absolutely unjust to hold a man respon- 
sible for stores without providing him with adequate 
physical means of protecting them. 

The materials and supplies of like nature should be to- 
gether. They should be arranged in an orderly manner to 
the end that they may be easily located and the arrangement 
may adapt itself to the taking of the physical inventory. 
Generally speaking, they should be arranged in sections or 
classes, alphabetically, or in the order that the accounts ap- 
pear in the material and supplies ledger and within the va- 
rious sections they should be arranged in racks, tiers, bins, 
closets or drawers, depending upon their nature. 

With regard to records, broadly speaking, it is desired 
to know — 

31 



Principles of Cost Accounting 

What comes in, 
What goes out, 
What remains. 

The record in each instance should show the name of the 
materials and supplies, the class, units, price per unit and 
cost. The original record of what comes in is the invoice. 
The original record of what goes out is the requisition. The 
ledger should show what remains. 

The invoice is the basis for taking up the stock by the 
stores clerk and constitutes his authority for so doing. In- 
voices are usually entered in a book of record in order to 
prevent the receipt and issue of stores without any trace 
thereof being found. Such a book of original entry is also 
valuable in that a summary of the cost of the invoices ob- 
tained therefrom supplies a means of securing a general or 
balancing account in the materials and supplies ledger. 

The requisition is the authority for the issue of materials 
and supplies. A knowledge of what it should recite is more 
essential than familiarity with some particular one of the 
various forms used. It should first of all receive a number; 
should recite the number of units required and give an accu- 
rate description of the materials and supplies to be issued; 
the lot, job or account number to be charged, and should 
bear the signature of some person in authority. It is not the 
practice to insert prices on requisitions until such time as 
the materials and supplies have been issued unless it is de- 
sired that specific materials at specific prices be issued. Or- 
dinarily, they are considered as issued in the order received, 
with accompanying prices. 'K summary of the requisition in 
a book of record is desirable especially for the purpose of 
supplying totals for the general or balancing account in the 
materials and supplies ledger. 

3* 



Materials and Supplies 

The ledger should contain an account with each class of 
materials and supplies and should be so arranged as to show 
the details of receipts and issues, setting forth in the case 
of receipts ; the 

Date 

Number of invoice or number of summary 

Units 

Price per unit 

Amount 
and with regard to issues ; the 

Date 

Number of requisition or number of summary 

Units 

Price per unit 

Amount. 
While the general or balancing account previously re- 
ferred to is not absolutely necessary since the materials and 
supplies ledger is controlled by the materials and supplies 
account in the general ledger, such an account facilitates the 
work of the stores department in that it is relieved of the 
necessity of constantly checking with the controlling account 
in order to ascertain if the ledger is in balance. The form 
of the ledger to be employed is largely a matter of choice. 
It matters little whether a bound book, loose leaf, or card 
system is used. 

The operation of the system obtaining in the stores de- 
partment requires that as to invoices they shall be numbered 
consecutively as received and the date of receipt noted 
thereon. Goods and prices should be checked and extensions 
verified, if same has not already been done. The invoice 
should be entered on the invoice record for summary pur- 
poses and the details of the invoice posted to the debit of 

33 



Principles of Cost Accounting 

the appropriate ledger accounts. Requisitions should have 
the number of the units actually issued noted thereon, with 
prices of the units issued, should be extended and entered on 
the summary and the details posted to the credit of the ap- 
propriate ledger accounts. 

A trial balance of the ledger should be taken monthly or 
oftener. The continuous posting of details of invoices and 
requisitions and the continuous balancing of the units of 
stock as well as the money values, proves valuable as a per- 
petual or running inventory. The balance of a given kind 
of stock as shown by the ledger may be verified by checking 
with the physical inventory, at regular periods or at such 
times as the stock is at a minimum. 

One report only is necessary from the stores department 
so far as the cost clerk is concerned and this should take the 
form of a summary showing particularly the cost of the ma- 
terials and supplies issued against the numbers of the various 
jobs in process. The report may be made monthly, bi- 
weekly, or as much oftener as judgment indicates or the cost 
department desires. A specimen report is given on page 35. 

In connection with the general discussion of materials 
and supplies a few words should be said regarding freight 
and cartage and labor in the stores department. While they 
will be discussed here from a strictly technical standpoint 
and such items added to direct cost, experience teaches that 
while perhaps not so accurate it is more practicable to in- 
clude them in the overhead. 

Inward freight may be added to the price per unit on a 
percentage basis ascertained by finding the ratio which the 
freight on the invoices bears to the cost thereof. Cartage 
unless it can be applied to specific invoices is more difficult of 
distribution. It is possible, however, to ascertain the ratio 

34 



Materials and Supplies 

of cartage to the total cost of goods and subsequently dis- 
tribute same over the invoices. A similar ratio of the cart- 
age to the cost of the individual invoices may be ascertained 
and the cartage then applied to the units. This method is 







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35 



Principles of Cost Accounting 

largely based on theory and the work involved frequently 
precludes its adoption in practice. 

Labor in the stores department is of two kinds : 
Manual. 
Clerical. 
Manual labor covers : 

(a) Receiving and putting goods in stock. 

(b) Taking goods out of stock and preparing them 

for issue. 
It will be seen that from a theoretical standpoint the 
manual labor involved may be divided between the two pro- 
cesses just mentioned, and that it, along with clerical labor, 
may be distributed over the invoices. In such cases, how- 
ever, the invoices would have to be held until the end of 
the week and the payroll ascertained, unless the labor were 
to be distributed daily. An arbitrary percentage is some- 
times added to cover this and other factors, but the objection 
to this plan is that it involves an adjustment at the end of the 
week or month in order to bring the books into agreement 
with the actual figures which the payroll shows. The prac- 
tice now commonly in use, is to throw this item, like inward 
freight and cartage, into the overhead for general distribu- 
tion. 



36 



CHAPTER VIII 
Labor 

The subject of labor can best be discussed by looking at 
it from the standpoint of the foreman or head of a depart- 
ment and ascertaining the nature and extent of the informa- 
tion he requires. 

Labor may be defined as services performed for which 
compensation is paid. The compensation may take the form 
either of wages or salary, and labor may be divided into two 
kinds, clerical and manual. Clerical, or administrative labor, 
is that performed with the head. Manual labor is that per- 
formed with the hands. Manual labor, in turn, so far as 
its application in manufacturing is concerned, may be divided 
into direct and indirect labor. The direct labor is frequently 
referred to as productive labor, and the indirect as non- 
productive labor. A choice of terms in this matter is of 
slight importance, except that the terms direct and indirect 
appear to be slightly more correct from a descriptive stand- 
point. It is usually easier to determine whether or not an 
operative is directly or indirectly engaged upon the product 
than whether or not he is producing anything. The direct 
labor may be applied either to the work performed at the 
hands of the operatives or through the medium of machines. 
Such labor is always expended in connection with, but not 
specifically applied upon, the product. It is reasonable to 
suppose, looking at the subject from the standpoint of the 
foreman, that with regard to the work of the individual the 

37 



Principles of Cost Accounting 

information required would be something of the following 
nature: 

i. What the operative does; the nature of the work in 
which he is engaged, and the particular job upon which he is 
working; 

2. The unit of compensation, whether it be on a time or 
a piece or job basis ; if on the time basis, whether he is work- 
ing by the hour, day, week or month; if on a piece basis, the 
number of units produced; if on a job basis, the amount of 
time employed on a job; 

3. The rate of compensation; 

4. The amount earned. 

What applies to the individual applies to departments, 
and in order to obtain the same information with regard to 
the departments that has been obtained with regard to in- 
dividuals it is only necessary to multiply the information 
per individual by the number of individuals in the depart- 
ment. 

What applies to the departments applies to the plant as 
a whole, and in order to obtain this information with regard 
to the plant as a whole it is only necessary to multiply the 
departmental information by the number of departments. 
It is apparent from the above that it would be advisable to 
have a summary of the entire plant, showing 

1. The amount earned by each individual; 

2. The amount of work of the operatives, taken collec- 
tively, which applies to each lot or job or class of work in 
process. 

3. The total amount earned by all operatives. 

As to the reasons for recording these three points of in- 
formation, it may be said that with regard to the first it is 
necessary to ascertain the amount of the payroll liability at 

38 



Lab 



or 



the end of each period, in order that the accounting depart- 
ment, or more properly speaking, the paymaster, may be 
informed as to the amount necessary to meet the payroll; 
second, the liability to each individual, or the amount which 
he is entitled to receive at the hands of the paymaster on 
pay day; third, for the purpose of distribution, in order that 
the amount applicable to each job or lot may be ascertained. 
Having determined the information necessary, the matter 
of records may now be considered. These will, of course, 
comprise three kinds; those pertaining to the individual; 
those pertaining to the department; those pertaining to the 
plant as a whole. With regard to those of the department 
and plant as a whole, it is unnecessary to say scarcely any- 
thing more than that they are either partial or complete 
summaries of the individual records. The record of the 
individual, as above indicated, should show — 
i. His name or number; 

2. The nature of the work upon which he is engaged; 

3. The number of units produced, or amount of work 
performed; 

4. The rate of compensation; 

5. The amount earned. 

The origin of the individual record will depend largely 
upon — 

1. The nature of the work; 

2. The intelligence of the operative; 

3. The basis of compensation. 

The members of a railroad construction gang would not, 
as a rule, keep their own records. Laborers in a foundry, 
on account of the low order of intelligence sometimes obtain- 
ing, would probably not keep their own records, whereas 
operatives on clothing, being of a higher grade and em- 

39 



Principles of Cost Accounting 

ployed upon piece work, might, in some cases, record their 
own work. 

The form to be employed in keeping such records would 
depend upon the type of production, whether single or mul- 
tiple unit, and the basis of compensation, whether time or 
piece. 

If the time basis were in use, a time book kept by the 
foreman or some delegated employee might be used for 
recording day labor. 

If the hour were the unit of time, it is more probable 
that the time would be recorded upon a card, which might be 
kept by the operative or by some employee designated for 
this work. 

In cases where the piece basis is employed for the re- 
cording of work, labor tickets are commonly used. These 
are either given out to employees upon the completion of 
work, or they may be in the form of coupons attached to an 
order, which are detached by the employee when the job is 
completed. 

Labor tickets may also be arranged so that they may be 
punched by the foreman or some designated employee when 
occasion requires. 

In the first of the two instances above cited, they are re- 
tained by the operatives until the end of the week or wage 
period, when they are turned in as vouchers and made the 
basis upon which the payroll is constructed. The labor at- 
tendant upon the counting of coupons is sometimes over- 
come by issuing them in strips or having them pasted in 
books something on the same order as those issued by several 
well-known concerns who give trading stamps with pur- 
chases. Rough outlines, indicating in a general way the 
scheme of time books, cards, and labor tickets follow. 

40 



Labor 

TIME BOOK— SINGLE UNIT PRODUCTION 

AND DAY LABOR 



Name 



M. T. W. T. F. S. Total 



Rate 



Amount 



Time Clock- 



TIME CARD— MULTIPLE UNIT 
AND HOUR BASIS 

Name or No Nature of Work. 



Job No. 


In 


Out 


No. Hours 


Rate 


Amount 






















































































- 













LABOR TICKET 



Name or No. 



Job No. 



Total Rate Amount 



41 



Principles of Cost Accounting 

In connection with the use of the above forms, and labor 
in general, calculating machines and mechanical devices of 
all kinds are invaluable in making extensions or in checking 
same where made by employees or foremen. 

No matter what form of individual record is used, the 
information therefrom should always be summarized, on 
the labor reports, so as to show, first, by departments, and 





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42 



Labor 

second, by a subsequent summary of these, for the entire 
plant — 

i. The amount of the pay roll; 

2. The liability to each operative; 

3. The distribution of labor. 

The latter information should be so arranged that the 
total amount applicable to each job may be seen at a glance. 

The summary serves two purposes ; first, that of supply- 
ing the payroll figures to the accounting department; second, 
the distribution of the labor to the cost department. A speci- 
men labor report is given on page 42. 



43 



CHAPTER IX 

Overhead 

In connection with this topic, the question may well be 
asked, what is meant by overhead? 

The term in itself is somewhat difficult to define, but it 
should convey to the mind the idea of indirect expense, or 
everything above prime cost; the expense of operating the 
business, not only of the plant, but the entire business; the 
expense, not only of manufacturing, but selling, administra- 
tion, and carrying on the business in general. It is variously 
called ''Loading," "Burden," "Indirect Expense," and (es- 
pecially by English authorities) "On Cost." 

Overhead divides into : 
Manufacturing; 
General. 

Manufacturing overhead begins with indirect labor and 
ends at the point of shipment from the factory. General 
overhead begins with the point of shipment and ends at 
Profit and Loss Surplus. 

It should be borne in mind that manufacturing overhead 
includes not only the miscellaneous expenses of a general 
nature incident to the manufacture, but in practice usually 
such items as indirect labor, inward freight and cartage, and 
minor merchandise and supplies which are inadaptable to 
direct distribution. 

General overhead has nothing whatever to do with the 
manufacturing. It covers the expenses incident to the 

44 



Overhead 

conduct of the business from the point -mere the goods hive 

tions from income, charges for reserves, and deductions 

from sales. 

It has just been said of overhead that it was indirect ex- 
pense. By that is meant exner.se which ires not rermit oi 

tion oi each class :: exuer.se whieh is aoclieable to each : ob 
or lot. and requires some kind oi arbitrary division or basis 
oi distribution 

In connection with a discussion of bases, the following 
questions are pertinent : 



i. Which is the most equitable 



2. Which is tl 



-a 



It is necessary :o choose some basis which deals fairly 
with all the work in process: rune which will distribute over- 
head to all jobs in actual process, and avoid loading jobs 
which are in the factory, but not in process. A variety of 
bases is available from which to choose. They divide gen- 
eraily into nve classes, namely: 
i. Time: 

2. Cost; 

3. Percentage: 

4. Production; 

5. Sales. 

L ode - me t ~m ba^'^ che~e 's the labor hour, the machine 
hour, and the overhead day. L nder the cost basis there is 
the wage hour and prime cc st. 

The 1 a : r hour may be deemed as the unit oi time 
whereby the work oi one operative is measured: in other 
words, it is the labor oi one operative one hour. 



-: 



—' Cost Accounting 

The machine hour is the unit oi time whereby the work 
of one machine is measured: i: is me work of one machine 
one hour. 

The overhead day is me unit of time whereby the amount 
of overhead applicable :: each unit of production is meas- 
ured: i: is the amount of overhead applicable :: :ne unit 
during the pe:i:d of :ne day. 

As a c:n:re:e example. let it be supposed that in job Xo. 
i there are zoo units and in job No. 2. 500 units. The 
amrun: of overhead for me rerird :: be distributed is 
52.000. Le: i: be assumed that job Xo. 1 has been in pro- 
cess 10 days and ma: job Xo. 2 his been in rrcess ± days. 
It will be apparent that job Xo, :. : insisting of 2 : : units in 
;::::ess : : days, would be equivalent to 2.000 units in process 
one day. and that job Xo. 2, consisting of 500 units in pro- 
cess -l days, would be equivalent t: 2.000 units in process one 
day. or taking the work collectively, the same as if 4,000 
units had been in ur::ess :ne day. If the amount of over- 
head ::r the peri: d. is divided by 4.000. me average iengtn 
of time the units collectively have been in process, a race ::' 
:: :en:s will be :b:aired. which may be made the basis for 
distributing tne overhead as between tne rv: jobs, in ac:::d- 
ance with the number oi overhead days involved, w hich in 
mis particular example barrens to be 2.00: in emit case. 
Having allocated the overhead t: jobs, it is a simple opera- 
:i:r :: reapportion i: ::■ units by dividing the overhead on 
rach job by the number of units involved, respectively. Tne 
amount oi overhead applicable :: er:h job is Si. coo, Job 
Xo. 1 invohd-g 200 units will, therefore, bear a cost over- 
head of 5/. : : per unit, while J:b Xo. 2 with 5 :o units will 
cost with regard to overhead S2.c: re: unit. 

As stated above, under me ::st basis, there is the wage 



: e r '<: e a d 

hour and prime cist from which re s rlrcr. Prime cost heeds 
no discussion, except to refresh the reader's memory that i: 
includes but two items, materials and supplies, and direct 
labor. 

The wage hour may be defined as the unit :: ::st. 
whereby the work of an Dperative is measured. It is the 
cc s: of the work of one operathre for me hour. 

Of the other rases :: distribution little reeds to be said. 
Students of the subject of cost accounting generally are 
familiar with the percentage basis, and it is only necessary to 
make mention of the fact that the amount of overhead ap- 
plicable to each job is that proportion which the number of 
units in the jot bears :: the total number of units involved. 

In the case :: the production basis the number :f units 
involved would be the number produced, and in the case :: 
^ales the number sold. 

The sales basis is not so frequently used in manufactur- 
ing concerns as i: is in wholesale and re:ad concerns organ- 
ized on a departmental basis, and where the distribution oi 
general expense is thought to be more accurately made by 
using the volume of sales of the respective departments as a 
basis. 

It has not been thought necessary to give the formula 
for distributing the overhead under each basis, since it may 
be easily deduced from the illustration covering the over- 
head day. 

The bases in all cases depend upon circumstances. The".' 
will be governed many times bv whether the employees are 
paid by the day or hour, or by the piece: they will be gov- 
erned by the nature of the business. A time basis would net 
ordinarily be employed in cases where goods are required 
to be invoiced before the records are completed, or the end 

47 



Principles of Cost Accounting 

of the month is reached. A job printing establishment, for 
instance, usually does work on an estimated basis and bills 
the job as soon as completed, adding to the prime cost an 
arbitrary percentage to cover the overhead and profit. 

The basis to be employed may also depend upon the fa- 
cility or regularity with which the books can be closed. 

While it is impossible to make any hard and fast rule as 
to the basis to be employed, such a division being entirely 
governed by circumstances, there is this to be said: the time 
basis is the ideal, and always preferable. No other basis 
should be considered if a time basis can be used. The argu- 
ment in its favor is that practically all the items entering 
into the overhead are of such nature that they accrue over 
a period of time. Examples of these, which, upon an- 
alysis, will be found to bear out the above statement, are as 
follows : 

Heat, Traveling expenses, 

Light, Advertising, 

Power, Salaries of officers, 

Direct labor, Rent, 

Salaries, manager and clerks, Taxes, 

Depreciation of equipment, Insurance, 

Salaries of salesmen, Interest. 

Having selected the time basis, there is the choice of the 
labor hour, the machine hour, and the overhead day, depend- 
ing upon the payment of compensation, whether the unit be 
one of time or piece. 

The arguments against the wage hour, prime cost and 
percentage bases are as follows: 

It is claimed that where the wage hour is employed the 
burden falls on the high-priced labor, which is unjust. The 

48 



Overhead 

skilled workman is usually more rapid, turns out more and 
better work, and requires less supervision. In the case of 
prime cost the burden falls upon the expensive material, 
while, as a matter of fact, the expensive product takes no 
longer to go through the factory than the inexpensive one. 
The objection to the percentage basis is that at best it is 
only an estimate based on past experience. It is constantly 
changing and should be constantly revised. 

Irrespective of the basis selected, the overhead should 
be summarized on the overhead report in order that the cost 
department may make the distribution to the various jobs. 
A specimen report is given as follows: 



Distribution of Manufacturing and General Overhead for the 

Month Exded December 31. 1008 





« 


t/5 


n 












£> 


<v 


rt 


Average Cost per 








6 

H 

O 


O 

c 

en 

a 
Q 




Q 

"S 

d 


Overhead E 


Overhead Day 


Total 
Overhead 


Manufac- 
turing 


General 


Manufac- 
turing 
Overhead 


General 
Overhead 


274 


2 


74 


148 


.157248 


.566481 


$107.11 


$23.27 


$83.84 


275 


2 


68 


136 






98.43 


.21.39 


77.04 


276 


2 


50 


100 






72.37 


15.72 


56.65 


277 


2 


55 


110 






79.62 


17.30 


62.32 


278 


5 


873 


4365 






3,159.08 


686,39 


2,472.69 


279 


8 


1437 


11496 






8,320.00 


1,807.73 


6,512.27 


280 


7 


1224 


8568 






6,200.92 


1,347.31 


4,853.61 


281 


2 


1464 


2928 






2,119.09 


460.43 


1,658.66 


Total . 




.27851 






$20,156.62 


$4,379.54 


$15,777.08 





Total Over- 
head 


Total Over- 
head Days 


Average Cost: 

per Overhead 

Day 


Manufacturing Overhead 


$ 4,379.54 

15,777.08 
$20,156.62 


27851 
27851 
27851 


.157248 
.566481 
.723729 


General Overhead 


Total 





49 



CHAPTER X 

Types of Manufacturing Cost Systems 

Manufacturing cost systems differ as to type. Accord- 
ingly, they may be classified as simple, compound, and com- 
plex. The type depends upon such things as whether the 
goods are produced on special or stock order or whether the 
work is performed by hand or machine, and the peculiarities 
of the business, such as necessity 7 for rendering invoices at 
the time of delivering work, for example. 

All types involve the same elements — materials and sup- 
plies, labor and overhead. The first two, in so far as their 
relation to the type of system is concerned, do not vary. 
The last named should be classified for the reason that it is 
comprised of items of two different kinds; those which per- 
mit of distribution to the operating departments and those 
which do not. A part of the overhead originates in the de- 
partments and must be applied to the product through such 
channels. Some of the overhead is foreign to the depart- 
ments both in its origin and application, and while it must 
be applied to the product, it never reaches it by way of the 
operating departments. Overhead in its relation to the oper- 
ating departments as affecting the different types of system 
is therefore classified as distributable and non-distributable. 

In the simple type all of the three elements go through 
the factory, without combination, direct to the product. The 
word "combination" is used here as referring to the elements 
from an accounting standpoint rather than a physical stand- 

50 



Types of Manufacturing Cost Systems 

point. In the compound type, material may go direct, while 
the labor and distributable overhead become combined or 
material and labor may be combined while distributable over- 
head goes direct. In the complex type, material, labor and 
distributable overhead become combined, while the non-dis- 
tributable goes direct. 

These combinations may represent departments, proc- 
esses, machines, or centers of production. There is no great 
distinction between "department" and "process" as used 
herein, except that more than one process may be included 
in one physical department. 





M 


SIMP 


_E 


TYPE 


i 






\y 




\ 






i 


L 


2 


> — 

1 








J 








O 


3 











In the accompanying illustrations, where an attempt is 
made to bring out more clearly the subject matter of the 
preceding paragraphs, departments are indicated by the let- 
ters — A — B — C; the elements of cost by the letters, M, L, 
O — D, and O, N — D; and the jobs by numbers. 

Words and graphics almost fail when an attempt is made 
to describe briefly and clearly, or to illustrate, the complex 
type of cost system. It may be referred to as a group of 
small cost systems wherein each operating department con- 

5i 



Principles of Cost Accounting 



stitutes a member. It might aid in the illustration if, in the 
diagram illustrating the complex type, one were able to im- 
agine the departments "A — B — C" as containing within their 
respective limits the diagram of the simple type sufficiently 
reduced in size to permit of such treatment. 



COMPOUND TYPE 




In the operation of the complex system, materials and 
labor may be combined within a given department and car- 
ried forward, or the combination may be extended to in- 
clude all of the three elements and similar treatment follow. 
The last named procedure is difficult of accomplishment, 
except where conditions have been standardized and an over- 
head rate can He ascertained. The difficulties in the way of 
success in the absence of such a rate are as follows : 

i. The cost record must follow the product. 

2. The distribution cannot be made until the end of the 
month or period. 

$2 



Types of Manufacturing Cost Systems 

COMPLEX TYPE 




TO JOBS 



3. The product must go forward when required for 
physical treatment, irrespective of the cost record. 

Whether or not the rate is correct cannot be determined 
until the end of the period, when the actual amount of over- 
head for the period has been ascertained and the true rate 
found. 



53 



CHAPTER XI 

When Departmental Distribution of Overhead is 

Indicated 

Since the time when Adam Smith advanced and substan- 
tiated the theory that a division of labor increases produc- 
tion, the tendency on the part of the manufacturer toward a 
highly developed physical organization has been constantly 
increasing. Manufacturers have learned that by segregating 
and controlling their materials and supplies and dividing the 
operatives into departmental groups, increased production 
and greater efficiency result. Arranging the departments so 
that the course of the product is ever forward, results in a 
great saving of time and a corresponding increase in the 
amount of work of which the organization is capable. In 
the more modern plants special attention has been given to 
the physical arrangement of the various departments. The 
stores department where the incoming material is received 
is located as near as possible, not only to the department 
where the first operation of labor is performed, but to the 
means of transportation, whereby the material is received. 
The course of work is constantly forward, never doubling 
back or going twice over the same route, and finally reaching 
the shipping department which is located adjacent to the 
shipping facilities. The effect which such an organization 
has upon the elements of cost is decidedly simple except in 
the case of overhead. The materials and supplies present 
no particular problem, since in no matter which type of sys- 

54 



When Departmental Distribution of Overhead is Indicated 

tern is involved, they emanate either from the main stores, or 
what might be termed branches of the main stores located 
in the departments and known as department stores. The 
direct labor originates in the various departments and causes 
no particular trouble in its handling. The treatment of the 
overhead is the problem which is hardest to deal with. 
While the statement has been made heretofore that it was 
inadvisable in the simple type of system to distribute the 
overhead to departments, and subsequently apply it to the 
product, it must be borne in mind that in the compound and 
complex type the situation is entirely different. These types 
frequently have to provide for complex and diversified 
product, and in such instances a departmental distribution 
of the overhead is not only desirable for statistical purposes, 
but absolutely necessary in order to obtain results which 
most nearly approach correctness. 

In the case of diversified product certain units go through 
all departments, certain units go through a part only of the 
departments, and in either instance certain units may go into 
departments where the overhead varies from heavy to light. 
It would be manifestly unfair to charge the product with 
overhead of departments through which it has not passed, 
or to burden product going through departments wherein it 
is heavy. Where a variation of the overhead exists it is 
unquestionably more correct to localize and apply it to the 
product at points of contact. The justice of so doing is 
shown by the illustrations wherein the local and general 
methods are compared on page $6. 

In the following tabulation "light" is the item which has 
been selected for distribution. The total cost of the light 
for the period was $24, used in the various departments, 
designated A, B, C as indicated. It is assumed that job No. 

55 



Principles of Cost Accounting 

i was 34 hours, and job No. 2, n hours in going through 
the three departments as indicated in the tabulation. By dis- 
tributing the overhead to the respective jobs from depart- 
ments, it is apparent that job No. i would bear $18.40 and 
job No. 2, $5,60; as against the respective amounts $18.13 

Departments 
Total ABC 

Light $24.00 $10.00 $8.00 $6.00 

Job No. 1 34 hours 8 hours 16 hours 10 hours 

" " 2 II " 2 " 4 " 5 " 

45 hours 10 hours 20 hours 15 hours 

Departmental Distribution 
Job No. 1 Job No. 2 

A $8 . 00 $2 . 00 

B 6 . 40 1 . 60 

C 4.00 2.00 

$18.40 $5.60 



General Distribution 

No. 1 No. 2 



$18.13 15-87 



45 )$24.oo .5333 

•5333 
34 II 

21332 5333 

15999 5533 

$18.1322 $5.8663 



and $5.87, were the overhead to be apportioned on the basis 
of total hours without regard to the amount of time spent 
in the respective departments. 

It has been previously stated that one of the principal 

56 



When Departmental Distribution of Overhead is Indicated 

objects of departmental distribution was to secure statistical 
information. Such information is needed for administrative 
purposes and affords an opportunity for comparison which 
is invaluable. It may be made to serve as an index to effi- 
ciency. By distributing to the centers of production, such as 
departments, processes, or men, the items of expense or cost 
affecting such centers, and redistributing in turn to the units 
of product undergoing process the expense or cost thus con- 
nected, the establishment of a rate or amount per unit is 
made possible, which furnishes a ready means of comparison 
and indicates the capability of the operating center involved. 
In like manner items of cost may be grouped around ma- 
chines so as to produce similar results. The obtaining of 
rates has the effect of creating standards, while perhaps not 
standards in the scientific sense, at least temporary standards 
which measure capacity and ability for work and answer 
that purpose until replaced. In this way they serve as an 
index to efficiency. Through the means of such statistics it 
may become evident that the increased cost of a certain pro- 
cess is due to the idle time or inefficiency on the part of the 
operatives. This may have occurred on account of a falling 
off in the amount of work, some fault in the method of dis- 
tributing work, or delay on the part of the foreman in so 
doing. Proper statistics can be made to indicate such condi- 
tions promptly, thus paving the way to the application of 
remedies. Such remedies may be brought about, first, on 
the part of the foreman, by laying off a part of the force, or 
improving the method of distributing work; second, on the 
part of the superintendent in causing the foreman to become 
more efficient, either through the aid of advice, or such other 
measures as may suggest themselves in view of the circum- 
stances surrounding the case. 

57 



CHAPTER XII 
Defective Goods, Waste, Shrinkage and Idle Time 

Incident to the processes of production there frequently 
occur certain irregularities which complicate the problem of 
obtaining accurate costs. 

In the casting of soil pipe and fittings, air bubbles and 
failure of the molten metal to run evenly cause many defec- 
tive pieces. In the cutting of half-soles out of sides of 
leather there is waste. In the importation, roasting and 
packing of coffee there is loss through shrinkage. In the 
case of operatives paid by the hour there will be time be- 
tween jobs which will be lost. Hence, several somewhat 
knotty* problems present themselves in the form of the treat- 
ment of defective goods, waste, shrinkage and idle time. 

With regard to defective goods there are three methods 
available. The first is to divide the cost of the job or lot by 
the number of perfect units, thereby buying, in the cost of 
the perfect units, the cost of the defective work. The second 
way is to divide the cost of the entire lot or job by the num- 
ber of the perfect units, after deducting the cost or scrap 
value of the defective work. The third way is to set up the 
defective work at its actual cost and carry it through as de- 
fective work, adding to the first cost any subsequent cost ap- 
plicable thereto. As an illustration of the first method, 
assuming the cost of producing ioo perfect units to be S500 
— it is evident that if only 98 perfect units result the cost will 
be $5.10 per unit. In the case of the second method, the 

58 



Defective Goods, Waste, Shrinkage and Idle Time 

cost will be $5.06, if it is assumed that $4, being the scrap 
value of the imperfect units, has been deducted from the 
cost of the lot, and the balance of $496 divided by 98 per- 
fect units. In the case of the third method, the cost per unit 
will be $5 — 98 being perfect and 2 imperfect. The second 
method is probably the most common. 

One of the collaborators on "a uniform method of cost- 
finding for steel foundries" has, in effect, this to say on the 
subject: 

"Defective castings fall naturally into two divisions. 
First, those discarded at the foundry as imperfect, and sec- 
ond, those returned by customers. The reason for discard 
at the foundry may be either on account of construction, due 
to the complication of pattern or thinness of section, or im- 
perfect practice. In such cases the job should be charged 
with the material, and labor credited with metal at scrap 
value, and the balance divided by the number of good cast- 
ings. As a prevention against the return of defective cast- 
ings by customers, the cost should be loaded with an arbi- 
trary percentage based on the cost less the scrap value which 
should be credited to the proper reserve." 

In the manufacture of hats, for example, the third 
method, while perhaps not most commonly used, is the most 
scientific. Defective hats are known as "knock-downs." 
The cost of "knock-downs" is of considerable importance. 
The question presented is, whether or not it pays to finish 
up for sale hats which are imperfect when formed. Is it 
good practice to load the cost of "knock-downs" up to the 
point of "stock bodies," on perfect hats, and finish up for 
sale a hat, the proceeds from the sale of which is considered 
as so much "velvet?" As a result of such practice "knock- 
downs" might very easily be sold at a considerable loss, 

59 



Principles of Cost Accounting 

whereas, if the proper information were available, the super- 
intendent would be enabled to decide whether or not imper- 
fect bodies might be profitably completed. 

Waste and shrinkage seem to present similar characteris- 
tics and would seem to be subject to the same treatment if 
it were not for the fact that in the case of waste something 
may be recovered from the scrap, whereas shrinkage leaves 
nothing behind which may be realized upon. 

To illustrate by a theoretical example the treatment of 
waste, let it be assumed that a side of leather 2^x3^4 ft. 
square, containing 1053 square inches, costs $4.21. If a 
pair of soles averages 80 square inches and out of the side, 
allowing for the irregular edges, twelve pairs of soles rep- 
resenting 960 square inches can be cut, the remaining 93 
square inches will be waste. Expressed in dollars and cents, 
the situation will be as follows: cost of 12 pairs of soles, 
$3.84, or 32 cents per pair; waste, 37 cents; total, $4.21. 

The waste may be treated in three ways, namely, charged 
to profit and loss ; given a scrap value and deducted from the 
cost of the side; or loaded onto the cost of the 12 pairs of 
soles. 

The first treatment is not desirable. The second is not 
practicable, since while the pieces will doubtless be used up 
it is not possible to assign a value to them. The third 
method seems preferable and will increase the cost per pair 
to 35 cents. 

Shrinkage involves no question of scrap value. It repre- 
sents the invisible disappearance of weight through evapo- 
ration. It may be treated in two ways, viz., charged to profit 
and loss or made to increase the cost of the product that 
remains. The latter is preferable. 

Suppose that a merchant were to purchase a bale of to- 

60 



Defective Goods, Waste, Shrinkage and Idle Time 

bacco weighing 200 pounds for $194. The cost would be 97 
cents per pound. If at the time of sale at $1.10 per pound 
the contents of the bale have shrunk to 194 the cost per 
pound will have increased to $1.00. The theoretical ques- 
tion now presented is — "Has the merchant sold 194 pounds 
of tobacco at 97 cents per pound and made a profit of $31.82 
or 194 pounds at $1.00 per pound and realized a profit of 
$26.00"? Obviously, the net result is the same in either 
case, since if the first method of handling the transaction is 
selected the gross profit of $31.82 will be offset in the profit 
and loss account by the loss on 6 pounds of shrinkage at 97 
cents, or $5.82. While either method may be said to be 
correct, the second is to be preferred, under ordinary cir- 
cumstances, since it facilitates the work of the cost depart- 
ment and leaves no profit and loss adjustment to be taken 
into consideration. 

Idle time affects the costs in the same manner as shrink- 
age. If a man is paid $2.40 for an eight-hour day and works 
only 6 hours the result is a cost per hour of 40 cents per 
hour instead of 30 cents. If his time is being charged against 
a piece of work it is apparent that it must be charged at 40 
cents instead of 30 cents unless it is desired to charge 2 hours 
of his time at 30 cents an hour to profit and loss. 

Loss of time between jobs has the same effect, although 
as a practical matter many concerns now employ time clocks 
where the finishing time on one job and the starting time on 
the succeeding job are simultaneously recorded. 

What is sometimes called "a profit on labor" is merely 
a percentage added to the hourly rate paid to the operative 
which experience shows to be necessary in order to provide 
for the idle time incident to break-downs and delays of one 
kind or another. 

61 



Principles of Cost Accounting 

Idle time will ordinarily be charged to cost of production, 
but where abnormally extended as in the case of certain op- 
eratives paid during a strike or other periods of enforced 
idleness the time should be charged to profit and loss. 

The same thing may be said of defective goods, waste 
and shrinkage, that while ordinarily the cost of production 
should be loaded to provide for such loss, under abnormal 
circumstances such, for example, as damage to raw material 
by water, the loss should be charged off. 

A general rule with regard to these items may therefore 
be formulated as follows : 

Where the loss is incident to the production it should be 
charged to cost. Where the loss is an extraordinary one and 
not connected with the production the loss should be charged 
to profit and loss. 



62 



CHAPTER XIII 

Distributable Overhead and the Bases of 
Distribution 

In making the distribution of such overhead as permits 
of distribution to the various departments, care should be 
taken that only such overhead be distributed to the respective 
departments as distinctly applies to them. Such overhead as 
applies must be analyzed and some consideration given to 
the departments as to their physical characteristics, the ca- 
pacity of their contents, and frequently the value of same. 
In this connection there must be considered the floor space, 
cubic contents, value of the machinery and the horse-power 
of same. 

It is probable that before proceeding to the discussion of 
the items to be distributed some thought should be given 
to certain of these items as to the economic and other theo- 
ries concerning them. Reference is made especially to rent, 
taxes, insurance, and interest on capital invested in machinery 
and tools. 

Under the economic theory, these items are not consid- 
ered as a part of the manufacturing overhead. Under cer- 
tain popular theories advanced by engineers and accountants, 
these items play a most important part. The economist, and 
the accountant who endeavors to base his accounting on a 
substantial economic foundation, argues that rent plays no 
part in the manufacturing cost. It is an item of general 
overhead, to be taken into consideration in fixing the selling 

63 



Principles of Cost Accounting 

price, but from the standpoint of the business, taken as a 
whole, is a deduction from income, and no part of manufac- 
turing costs. It is probable that before this question can be 
satisfactorily settled, considerable research on the part of 
men possessing the necessary qualifications will be necessary. 
It has in its favor, that its exclusion from manufacturing cost 
facilitates comparison where some concerns own their build- 
ings, while others are obliged from their lack of capital to 
share a portion of their income with the landlord. 

It will be pointed out by the opposers of this theory that 
a concern purporting to own its own plant may be, in fact, 
paying interest on capital borrowed for the purpose. It will 
further be pointed out by such persons that even though this 
were an investment of owned capital, taxes are paid on the 
property in lieu of rent and interest. This contention may 
be met by the supporters of the economic theory with the 
statement that there is not a sufficient similarity in amount as 
among these three items to permit of their being included in 
the manufacturing overhead and thus tend to obscure the 
true cost of manufacture and interfere with a comparison of 
costs composed of like items. 

There would appear to be no more reason for including 
interest on capital and taxes, than rent, in manufacturing 
costs, as on account of being similar to rent, they are more 
properly chargeable against income. 

The item of insurance also permits of some discussion. 
It is argued by the economists that insurance is not a true 
item of manufacturing cost. Insurance is a premium paid 
for the protection of capital, and being an expense of capital, 
considered from the standpoint of the business as a whole, 
is a deduction from income. Advancement of this theory is 
usually confronted with the query as to why the salary of 

«4 



Distribution Overhead and the Bases of Distribution 

the watchman at the factory, who is engaged in protecting 
the capital of his employer, is not treated as a deduction 
from income rather than a part of manufacturing expense. 

Having disposed rather indefinitely of the various theo- 
ries covering certain of the items making up the overhead, 
they may now be considered with regard to those which fall 
within the control of the operating department, and with 
regard to certain of these, those which may be said to fall 
specifically within the control of the foreman, as well as those 
which do not fall within the control of the operating depart- 
ment. They may be listed and grouped as follows : 



Under control of Operating De- 
partment 



Under control of- 
foreman 



Superintendence 



r Heat, 

Light, 

Power, 

Repairs and mainte- 
nance, 

Depreciation of ma- 
chinery and tools. 



fRent, 
Not under control of Operating I Taxes, 

Department ] Insurance, 

Llnterest. 

It will now be necessary to consider with regard to the 
above items their distribution to the departments and the 
various bases upon which they may be distributed. There 
may be eliminated from this class, repairs and maintenance, 
and depreciation of machinery and tools, since such items 
are local in their origin and do not require distribution. 

Heat may be distributed on a basis of cubic yards, after 
first obtaining the cubic contents of all departments receiving 
heat. The cost of heat for all departments is divided by the 
number of cubic yards contained in same, and multiplying 
the rate thus obtained by the number of cubic yards in each 
department, to ascertain the cost of heat applicable to each. 

65 



Principles of Cost Accounting 

The distribution of light depends upon whether or not 
facilities for measuring same by meter are available. Where 
electricity is used, and meters are found, the unit of measure- 
ment is the kilowatt hour. Where gas is measured by meter, 
the unit of measurement is the cubic foot. Where meters 
are not available light is distributed on the basis of square 
feet of floor space. 

Power is apportioned on a basis of horse-power hours. 
This unit is obtained by multiplying the horse-power of the 
machines by the number of hours in operation. 

Superintendence may be distributed on a basis of direct 
labor hours; rent on a basis of square feet; taxes on a per- 
centage basis, the percentage being computed on the value 
which the contents of any given department bears to the total 
assessed value of all departments. 

Insurance may or may not permit of localization. It 
should be localized, if possible; if impossible, it should be 
distributed on the basis of value. Interest should likewise 
be apportioned on the basis of value. 

It has not been thought necessary to repeat in each in- 
stance the formula for distribution, on account of being 
practically the same in each instance and having been once 
given in connection with the distribution of heat. 



66 



CHAPTER XIV 

Machine Rates 

Distribution may not cease with departments. Having 
allocated the items of expense thus, we may go on further 
and redistribute within departments to processes, to ma- 
chines, or to individuals. The theory being in each case the 
same, but as applied to machines slightly more interesting, 
we may proceed with its application thereto, and to discuss 
the question of machine rates. 

The subject matter for distribution will depend upon the 
type of system, and may embody overhead alone, a combi- 
nation of labor and overhead, or a still further combination 
of material, labor and overhead. The rates are of two 
kinds — the departmental, sometimes referred to as the "old" 
machine rate, and the allocated rate, sometimes known as 
the "new" machine rate. Either may be a fixed rate (de- 
veloped in a previous period) or a scientific rate (estimated) 
and either may involve one or two supplementaries. 

In order to find the departmental rate, it is necessary to 
divide the actual overhead of the department by the number 
of actual machine hours for the entire department. A rate 
is thus obtained which furnishes a basis for distributing the 
overhead to the jobs, in accordance with the number of ma- 
chine hours shown by the respective jobs. This method is 
satisfactory, in case there is no bench work and the machines 
are of the same type, of the same value, occupy the same 
amount of floor space, and use the same amount of power. 

It should be noted that this method pro-rates the over- 

6 7 



Principles of Cost Accounting 

head. Objection to it is found in that it does not sufficiently 
localize the overhead, and the objection gives rise to a de- 
mand for a method which will permit of as much direct dis- 
tribution as is possible. To supply this demand, the allo- 
cated machine rate was evolved. The rate here is obtained 
by dividing the total cost of labor and overhead as allocated 
to individual machines by the number of hours the corre- 
sponding machines are in operation. The cost applicable to 
the jobs in question is obtained by multiplying the rate by 
the number of machine hours on the respective jobs. This 
method may be used to advantage where the majority of 
processes are machine. Bench work, of course, complicates 
matters, and attention to the physical arrangement should be 
given in order that machines of the same type may be in 
the same group. 

The fixed rate contemplates the use of one determined 
upon the basis of actual running time during the next pre- 
ceding month or period. The charge to the jobs is obtained 
by multiplying the number of operating hours per job by the 
rate and crediting to the overhead a corresponding amount. 
The amount so credited, which, it will be noted, is an estimate 
based on past experience, will be offset at the end of the 
current month or period by the actual cost during the period, 
and as usually happens a difference will result. 

This difference may mean that the fixed rate upon which 
the charges to jobs have been made was either too high or 
too low, and the difference must be distributed either as a 
debit or a credit to the cost of the jobs, in accordance with 
whether the fixed rate was too high or too low. It gives rise 
to what is known as a supplementary rate, and which is ob- 
tained by dividing the "difference" by the actual number of 
operating hours. The redistribution is brought about by 

68 



Machine Rates 

multiplying this supplementary rate by the number of actual 
operating hours shown by the respective jobs. 

The scientific rate is the most complicated, but produces 
the most satisfactory results. It contemplates the estimating, 
or predetermining, of certain items of overhead for the year 
or period. Among these are : 

Superintendence, Depreciation, 

Heat, Taxes, 

Light, Insurance, 

Power, Interest. 

The scientific rate also contemplates operation on the 
basis of maximum running time for each machine during the 
entire year or period. Items of overhead are first distributed 
to departments and subsequently to machines. The machine 
cost is then divided by the maximum operating hours in order 
to get a rate per hour. The charge to jobs is obtained by 
multiplying the number of actual operating hours devoted 
to the job, by the rate, and the crediting of a corresponding 
amount to the overhead. 

Idle time, as in the case of the fixed rate, gives rise to 
the necessity for further distribution and the obtaining of 
what is known as the first supplementary rate. This is ascer- 
tained by dividing the cost of the idle time by the total num- 
ber of actual operating hours, and the distribution by multi- 
plying the first supplementary by the number of hours on 
each job. As jobs are charged a corresponding credit is 
made to the overhead. It will be remembered that there 
are now two credits to the overhead, one arising at the time 
of applying the first supplementary. The process from this 
point is precisely the same as in the case of the fixed rate. 
Actual overhead for the month or period is now ascertained 
arid charged to the overhead, thereby offsetting the credits 

6 9 



Principles of Cost Accounting 

just previously mentioned and usually resulting in a difference 
between the actual overhead and the predetermined over- 
head, plus the first supplementary rate. The manner of dis- 
posing of this difference gives rise to the second supplemen- 
tary rate, which is obtained by dividing this difference by the 
actual operating hours on all jobs and distributing to the 
jobs in accordance with the number of hours each shows. As 
this last supplementary is charged, overhead is credited, thus 
actually balancing the overhead account. In order to bring 
this out, reference to the following ledger account, as well as 
the succeeding illustration, may be found helpful: 

OVERHEAD ACCOUNT . 



Actual $3,000 . oo 



$3,000.00 



Machine rate $2,000 . 00 

1st Supplementary 400.00 

2d " 600.00 



$3,000.00 



Actual time 2,000 



ILLUSTRATION 

Full Time Estimated Overhead Machine Rate 

2,400 hours $2,400.00 $1.00 



400 hours Idle hours X $1.00 =$400.00. 
2,000 hours)$400.oo 

. 20 = 1st Supplementary. 

$3 ,000 . 00 = Actual overhead. 
2 ,400 . 00 = Estimated overhead. 
2,00 0) 600 .00 = Excess to be distributed 
. 30 =2d Supplementary. 

575 Hours 720 Hours 705 Hours. 

Job No. I Job No. 2 Job No. 3 



575X$i.oo = $575.oo 720X$i.oo= $720.00 705X$i.oo= $705.00 

575X .20= 115.00 720X .20= 14400 705X .20= 141.00 

575X .30= 172.50 720X .30= 216.00 7°5X .30= 211.50 

$862.50 $1,080.00 $1,057.50 



Job No. 


2 




720X$i 
720 X 
720 X 


.00 = 
.20 = 
.30 = 


$720 

144 
216 


00 
00 

00 




$ 

50 
00 


i.oSo 


00 


$862 
1,080 






1.057 


50 






$3,000 


00 

70 







CHAPTER XV 

Wage Systems 

Before entering into a discussion of this subject a few 
words should be said as to the relation of wage systems to 
cost accounting. 

The success of a professional accountant depends in a 
large measure upon his value to the client. His value is dem- 
onstrated by his ability to save the client money. One of the 
principal ways of saving money is reducing cost. An ac- 
countant should therefore be in a position to indicate to the 
client the manner in which costs may be reduced. Wage 
systems undoubtedly lower costs, and the accountant in order 
to act intelligently and be of most value to his client should 
be familiar with the subject and the relative advantages and 
disadvantages of the various systems. 

The prophecy may also be made, that in the settlement 
of the ever-increasing difficulties between capital and labor, 
wage systems will not be an insignificant force. 

The constant struggle of to-day is to effect the reduction 
of costs. Why? It may be that competition requires it, or 
it may be due to a desire on the part of the manufacturer 
for increased profits. 

While it is quite evident that costs may be reduced by the 
reduction of any of the three elements composing same, it is 
probable that the item of labor presents greater possibilities 
of successful reduction than either of the two other elements. 

There are two ways in which labor cost may be reduced. 

71 



Principles of Cost Accounting 

The first is through the reduction of wages. The second is 
through an increase in the production. The first method 
produces a strenuous objection on the part of the laboring 
man: a complaint that he is being ill-treated, or perhaps his 
refusal absolutely to continue at reduced rates. The second 
method is the more scientific and satisfactory to the wage 
earner, and given the demand for unlimited production, is to 
be preferred by the manufacturer. 

As an illustration, whereby the same result is accom- 
plished, reference may be had for a moment to the tabulation 
which appears below and shows the application of the two 
methods to the casting oi pin trays. 

Workman Wage Production Trays Cost Per Unit 

i $2. 40 ::: .02 

(l) : si.so :_■: ,::5 

(2) 1 :-: 160 .015 

Considering S2.40 per day as the normal wage of a man 
who produces 120 trays, it is evident that the cost per unit 
will be .02. If the manufacturer desires to reduce the cost to 
.015. he may accomplish this result by decreasing the wage to 
Si. 80, assuming that the production remains constant, or he 
may allow the wage to remain at S2.40 and insist that the 
operative shall increase the production to 160 trays. 

The reduction of the wage to Si. 80 brings a storm of 
protest from the operative. Insistence that he shall increase 
his production causes him to become sullen, and perhaps 
complain that he is being driven. In the instance where his 
wage is reduced, if the workman continues, it is probable 
that he will "soldier.'' with the result, perhaps, that the pro- 
duction per day will fall from 120 to 90. thus, based on the 
wage of Si. 80, restoring the cost to .02. 

It becomes quite evident, then, that a reduction oi the 

72 



Wage Systems 

wage is practically out of the question, and that in order that 
the cost may be reduced, the production must be increased, 
and the question before us now is how this increase shall be 
accomplished. 

The small boy who is paid for doing chores, does them 
more cheerfully than if he is compelled to do them without 
compensation. The schoolboy who receives a quarter from 
his father every time his report card shows 100% in arith- 
metic, usually does better work in arithmetic on account of 
the quarter awaiting him. The quarter acts as an incentive. 
Laboring men are not unlike schoolboys in this respect. They 
will do more work per day and they will do better work per 
day, if some incentive is offered, than if driven to the same 
result. 

Let us assume that the incentive offered to the operative 
is one-half of the saving brought about through a reduction 
of the costs. It is not unusual to find that men, if offered 
the proper incentive, are capable, with ease, of doubling the 
production. Under such a condition, with a normal daily 
wage of $2.40 it is evident that the cost per unit would be 
.01. The saving per unit will be .01 which if equally divided 
with the workman, on a basis of 240 units produced, will give 
as the workman's share $1.20. The workman's daily wage 
will then be $3.60, while the net cost of production per unit 
to the employer will be .015. 

The conclusion to be drawn from the above is that the 
wage system, which has as its basis the sharing of savings 
with the employees, has accomplished the desired result of 
reducing costs, increased the wage of the employee, and 
thereby proved entirely satisfactory to all concerned. 

The following tabulation may bring out more graphically 
the preceding statement : 

73 



Principles of Cost Accounting 



Wage 






Production 










Cost 


Normal $2 . 40 

.creased Production $2.40 
H Saving to work- 
man 1 . 20 






120 

240 
240 
240 










.02 
.01 
.005 




orkman $3 . 60 


.0,5 


n 
c 


r W 

e a 
a 


B 

s 


e 

e Wage e 

System 


a 
s t 


e 

s 


r 




1 
c 
C 


e 



In discussing the above, the question is often asked. Why 
not as an alternative, introduce piece rates? Here is an in- 
centive indeed. The benefit, however, accrues largely to the 
workman. It is true, of course, that there will be a certain 
amount of saving in the overhead, due to increased produc- 
tion, but that no saving will be effected so far as the labor is 
concerned. 

One hundred and twenty units at .02 will cost £2.40, 
and 240 units at .02 will cost S4.80. To use an expression 
popular in connection with the discussion of piece rates, oper- 
atives "work their heads off." 

Piece rates ultimately prove unsatisfactory to the work- 
man, because of the fact that as soon as the wage becomes 
excessive it is sure to result in a cut. The workman thus 
becomes dissatisfied and unconsciously adopts a standard. 

Mr. George Frederick Stratton, writing on the subject 
in the March, 19 10, number of "System," relates the fol- 
lowing incident: 

"A young man secured a job in the brass finishing depart- 
ment. He was a green man and started at day rates to learn 
polishing. Specializing on such work, he advanced sufBcient- 

74 



Wage Systems 

ly in three weeks to go on to piece work. In two months he 
jubilantly exhibited a pay check calling for $14.00 and was 
applauded by his family. 'It's pretty good now ! but it's as 
much as I'll get if I work there ten years.' 'How's that?' 
inquired his father. 'You're on piece work and you'll 
surely get more expert as the time goes on.' 'Sure thing,' 
retorted the young man, 'but $14.00 is the limit. If any 
man runs over that in our room, he'll get his head punched — 
and he'll get the rates cut, too.' " 

Piece rates may be effectively employed, provided the in- 
centive is restricted. That is to say, an incentive may be 
offered to increase production, if the rate is reduced on the 
surplus; for example: 

120 at .02— $2.40 
120 at .01— 1.20 
240 )$3.60(.01S 

It will be noted from the foregoing that the same thing 
has been accomplished in the application of piece rates to the 
problem that resulted previously where the daily wage basis 
was in effect. 

The application of the broad principle in the first instance 
is frequently seen in connection with machine work. Here 
reduction in cost is effected through a saving in time, rather 
than an increase in production. If the average or normal 
time required for the accomplishment of a certain task is 
eight hours and the rate of compensation or machine cost 
is .60 an hour, the cost of the job will be $4.80. If by close 
attention to his work, and the intelligent application of all 
his faculties, a workman is able to reduce the time of opera- 
tion to six hours, it is quite apparent that at the same rate 
per hour, or machine cost of .60, he has effected a saving 
of $1.20. Even viewed from the standpoint of equity, there 

75 



Principles of Cost Accounting 

would appear no reason why, in the natural order of things, 
the workman should not receive some benefit accruing 
through the saving of $1.20 at his hands; why he should 
not receive some premium or bonus for having accomplished 
this saving. 

Whether or not he is entitled to it from an equitable stand- 
point, it is certainly good judgment on the part of the em- 
ployer to share the saving with him, to the end that he may 
have some incentive for continuing his efforts to lower the 
cost. If he receives half the saving, in the above mentioned 
instances it will amount to .60. It will be seen that his day's 
pay, assuming that he does no further work after accomplish- 
ing the task set, will be made up of two elements; one being 
the regular wage at a fixed sum per hour, and the other 
the premium or bonus for the saving in time, amounting re- 
spectively to $3.60 and .60, or a total of $4.20 for the day, 
as illustrated herewith : 



8 hours 
6 " 


at .60 
" .60 

"Too 


=$4.80 
= 3.60 


saving ) 2 
emium 1 


2)$1.20 
.60 


cost 7 


=$4.20 



This work taken in connection with an eight hour day, 
leaves the operative still two hours in which to work on an- 
other task and thereby further increase his daily wage. 

It should be borne in mind that increased speed and in- 
creased production give rise to an increase in the amount of 
defective work and a corresponding need for the establish- 
ment of an inspection department. 

Most wage systems are constructed on the principles out- 
lined above, and while some are known as premium systems 

76 



Wage Systems 

and some as bonus systems, there is only a very slight techni- 
cal difference between these two terms. The word "pre- 
mium" is usually employed to indicate a division in the saving 
in time, whereas, the term "bonus" implies an increased 
rate offered for speed and skill. 

Up to this point, the discussion has been confined entirely 
to the reduction of cost based on the saving of labor. We 
shall also have to consider a similar saving with regard 
to overhead, or to overhead in conjunction with labor. The 
most common type of system which takes into account both 
labor and overhead, has for its basis what is known as the 
differential rate. The rate per hour is arranged on a sliding 
scale which increases in proportion as the number of units 
produced increases. The workman who produces 12 units 
receives a proportionately higher rate per hour than the 
workman who produces only 10 units. The system operates 
to the advantage of the efficient workman and to the disad- 
vantage of the inefficient workman. It is said to "differenti- 
ate" between the good workman and the poor workman. On 
this account the rate is known as the "differential." 

While it will be seen from the tabulation herewith sub- 
mitted that the increase in the number of units produced 
carries with it an increase in the rate, and a consequent in- 
crease in the wage of the operative, a consideration of the 
units taken in connection with the overhead will show that 
as the units of production increase, the overhead decreases. 

DIFFERENTIAL RATE 
Overhead $13.20 



Labor Cost 


Overhead Cost 


Cost per Unit 


10 units at .30 = $3.00 




$1.32 


$1.62 


10 " " .32= 3.52 




1.20 


1-52 


12 " " .34= 4-o8 




I.IO 

$1.65 


1.44 


8 units at .26= $2.08 


$1.91 




77 







Principles of Cost Accounting 

The advantages of the differential rate are that it offers 
an incentive to the workman and increases his wage if he 
takes advantage of it. 

From the standpoint of the employer it is equally advan- 
tageous, in that it decreases cost by increasing production, 
and in general raises the standard, by enabling the employer 
to distinguish between the efficient and inefficient workman. 



78 



CHAPTER XVI 

The Fixing of Wage Rates 

The success of all wage systems depends upon the fixing 
of rates. Before a rate may be fixed it is necessary to deter- 
mine, 

i. Which are the best methods and tools to use. 
2. What length of time is required by the workman of 
average capacity to perform a task without un- 
due exertion? 
The necessity 7 for this sort of thing was first seen about 
thirty years ago, by Mr. Frederick W. Taylor, who was at 
that time connected with the Midvale Steel Co. Mr. Taylor 
went about the task of gathering statistics and classifying 
them in a scientific manner, so as to permit of their use in 
determining the best methods and tools to use, and the time 
required for the performance of specific tasks. In a paper 
on the subject of Shop Management, Mr. Taylor makes the 
statement that the two facts which appear most noteworthy 
in connection with the method of Shop Management are: 
"First — What may be called the great unevenness or lack 
of uniformity shown even in our best run works, in the de- 
velopment of the several elements which together constitute 
what is called the management." 

"Second — The lack of apparent relation between good 
shog management and the payment of dividends." 

"The art of management has been defined as knowing ex- 
actly what you want men to do and then seeing that they 

79 



Principles of Cost Accounting 

do it in the best and cheapest way. What the workmen want 
from their employers beyond anything else, is high wages, 
and what employers want from their workmen most of all, is 
a low cost of manufacture. The possibility of coupling high 
wages with a low labor cost rests mainly upon the enormous 
difference between the amount of work which a first-class 
workman can do under favorable circumstances, and the 
work which is actually done by the average man. First-class 
men are not only willing but glad to work at their maximum 
speed, provided that they are paid from 30% to 100% more 
than the average of their trade." Having in mind the above 
facts, Mr. Taylor made a careful study of the best methods 
and tools to use, and evolved a system for standardizing the 
time of operations which may be best described in his own 
words, as follows : 

"In 1883 while foreman of the machine shop of the Mid- 
vale Steel Company of Philadelphia, it occurred to the writer 
that it was simpler to time with a stop-watch each of vhe ele- 
ments of the various kinds of work done in the place, and 
then find the quickest time in which each job could be done, 
by summing up the total times of its component parts, than 
it was to search through the time records of former jobs and 
guess at the proper time and price. After practicing this 
method of time study improvements for about a year, as 
well as the circumstances would permit, it became evident 
that the system was a success. The writer then established 
a time study and rate fixing department, which has given 
out piece work prices in the place ever since." 

The Taylor system, while it imposes upon the manage- 
ment the burden of seeing that the work is done in the time 
and manner specified, also provides a higher rate for in- 
creased efficiency. 

80 



The Fixing of Wage Rates 

In 1886 Mr. Henry Towne originated a wage system 
which was improved and made practical by Mr. F. A. Hal- 

sey, who in 1891 described the system in a paper before the 
American Society of Mechanical Engineers. The Towne- 
Halsey system contemplates as a standard the quickest time 
in which a job has been done. The workman who does it 
in the shorter time receives the same wage per hour for the 
time he is engaged upon the job, and in addition a premium 
for having worked faster, which ranges from one-quarter to 
one-half of the saving in time. 

It may be stated here, that scarcely any system has yet 
been evolved to which there has been no objection raised. 
An objection was raised to the Halsey system in that the rate 
became excessive after 50% had been saved. 

In 1 901 Mr. James Rowan read a paper before the me- 
chanical section of the International Engineering Congress, 
in which he advocated the allowance of a bonus based on 
such a percentage of the regular wage as the time saved bears 
to the standard time. For example, if the standard time for 
the operation were one hour, and the standard wage .30, a 
saving of six minutes would be equivalent to 10%, and 10% 
of .30, or .03, added to the standard wage would give as the 
wage per hour .33. Objection was found to this system, that 
the bonus was too great in proportion to the saving during 
the first hours saved. 

Among other systems which have gained both notice and 
popularity are : 

Cardullo, 

Searle & Nicholson, 

Gantt, 

Emerson. 
Under the Cardullo system the wage is arranged on a 

81 



Principles of Cost Accounting 

sliding scale based on the percentage of time saved, but is 
limited by the maximum, no matter how much time is saved. 

Searle & Nicholson advocate a system whereby the work- 
man receives one-half the time saved until the saving reaches 
50%, thereafter a percentage based on the ratio which the 
time saved bears to standard time. This is a combination 
of the Halsey &: Rowan methods and would seem to over- 
come the objections found to both. 

The Gantt system does not ditter materially in principle 
from the other systems, except that in addition to the reward 
for efficiency offered to the operative, and which Mr. Gantt 
specifies shall be liberal, the reward shall be extended to those 
who supply the operative with materials and appliances to 
enable him to maintain the efficiency specified. 

Before discussing the Emerson system, which serves as 
an introduction to the next topic, a few words may be said 
concerning the various profit-sharing and stock-distributing 
systems, which are coming largely into vogue. Rewards of 
this description are intended to promote co-operation and act 
as an incentive to the workman: to decrease cost by increas- 
ing production. They are not as a rule entirely successful. 
They fail usually, so far as the workmen are concerned, be- 
cause of the fact that the profits do not depend entirely upon 
the workman. A saving may be made by the manufacturing 
department through a reduction of cost whereby profits are 
insured, only to have such profits dwindle on account of the 
shortsightedness on the part of the selling organization, or 
through poor judgment on the part of an administrative 
officer. This objection may be overcome, however, by fixing 
a standard cost at which the product is credited to the manu- 
facturing department; any reduction in this cost being con- 
sidered as a saving attributed to the manufacturing depart- 

82 



The Fixing of Wage Rates 

ment and a part thereof set aside and distributed among the 
men as profits. Notwithstanding the fact that the general 
objection has been overcome, these systems are usually 
deemed to be unfair and inequitable, since it usually occurs 
that the men who contribute most to the profit get the smallest 
share thereof. Workmen as a rule prefer individual return 
for individual effort, which the wage system accomplishes. 

Mr. Harrington Emerson recognized this tendency of 
human nature when he originated the Individual Effort Sys- 
tem. 

The Emerson System became famous in connection with 
its adoption and use in the shops of the Santa Fe Railroad, 
to the extent that it is popularly known as the Santa Fe Sys- 
tem. The essentials of the Emerson System are: 

A. Standard time, or time in which the work should 

be done; 

B. A premium for efficiency. 

The premium begins at 66 2 /3 efficiency and gradually in- 
creases until 100% efficiency is reached, in which case the 
premium equals 20%. Above 100% efficiency the premium 
increases rapidly, constituting an increase of 1% premium for 
each increase of 1% in the efficiency. 



83 



CHAPTER XVII 

The Efficiency Department 

One of the most striking Innovations of recent times is 
that of the so-called efficiency department It is mentioned 
here. :.n acc:u:cc :: die close relation which .: bears :: Cost 
Accounting. It is urefiiei over by the efficiency engineer. 
whose duty it is :: determine the measure :: return which 
the employer shall receive for the money which he employs 
in manufacturing operations. 

The housewife who purchases in the market a bushel of 
potatoes for Mie dollar, expects to receive in retain tine stand- 
ard of quantity as well as the standard : : quality. It is con- 
sidered equally appropriate that the entrepreneur who in- 
vests a dollar in manufacturing operations should expect to 
receive a standard return of identity and quality. 

It is the duty of the efficiency engineer to endeavor id 
bring this about. His function is t: fix standards of quantity 
and quality. Just as the mining engineer makes an assay of 
::e. so the efficiency engineer tests the quantity ana quality 
of the material used as well as the quantity and quality of 
workmanship. He must have a bread knowledge of the four 
elements of organization, namely: 

Machinery, 

Men, 

Materials. 

Methods. 
He is the chief of stair, whose assistants are specialists in 

84 



The Efficiency Department 

the above mentioned lines. The staff determines what shall 
be done and prescribes the methods for accomplishing the 
work. 

The line organization performs the work in accord- 
ance with the methods prescribed, and has always at its com- 
mand highly specialized staff knowledge upon which it may 
call for assistance. 

Under such an organization, each branch of the work is 
in charge of one of the assistants. 

The man in charge of machinery has as his duty the 
standardization of all machinery and equipment. To him 
is assigned the task of securing the proper types of machines 
and tools which are the most efficient. He advises as to their 
care and decides upon the location of each, with a view to se- 
curing the most effectual progress of the work through the 
plant. One case is reported where a 40% increase in the out- 
put was secured by a rearrangement of machines. 

Another assistant chief of staff looks after men and con- 
ditions, which is one of the most interesting as well as the 
most difficult branches of the work. He supervises the stand- 
ardizing of conditions and requirements that fall within the 
scope of his duties. He plans, directs and advises as to 
the welfare of the employes. He sees to it that be- 
fore an employee is engaged, he submits to examination as 
to his moral, physical and professional qualifications. Emer- 
son goes to the extent of saying that "it ought to be as diffi- 
cult to enter the services of a great corporation as to pass 
the entrance examination to West Point; but once in, it ought 
to be a catastrophe for a man to be forced to leave; because 
the company provides so much that he cannot provide him- 
self, for his physical, financial and professional welfare, and 
because it rewards individual efficiency." 



Principles of Cost Accounting 

Great attention is being paid in these days to the welfare 
of employees. Great corporations as well as individual em- 
ployers are giving more attention to providing better light 
and better air. Many manufacturing plants are equipped 
with automatic exhausts for the removal of dangerous parti- 
cles of dust, which heretofore have been allowed to fill the 
atmosphere in which the employees worked. Overcrowding 
of work rooms is being avoided and operatives are provided 
with a place to wash and bathe, and in many instances com- 
fortable dining rooms in which to eat. Medical attention is 
furnished and ample means of escape from the buildings in 
case of fire provided. In order that ample opportunity 7 for 
recreation may be had, club rooms and club houses, with 
billiards, pool, bowling and all other appurtenances thereto, 
are provided by the company free of charge. In some cases 
the club house contains an auditorium where entertainments 
are held and lectures are given. One Western company 
went so far as to provide and equip a first-class bar, on the 
theory that the men would have liquor and the company pre- 
ferred that they should have good liquor rather than poor. 

Materials are looked after by another assistant chief of 
staff, who controls both the purchasing agent and the stores 
department. He standardizes the material to be used and 
specifies the kind and quality to be purchased. He prescribes 
the methods necessary for its care, to the end that it may not 
deteriorate, be wasted or be used extravagantly. 

The man in charge of methods, prescribes the methods 
whereby standards may be attained. It is his duty to advise 
workmen as to the most efficient use of equipment, machines 
and tools. In short, he is called upon to provide methods 
which will result in doing the most work in the shortest time 
and better work with less effort. 

86 



The Efficiency Department 

The efficiency organization, of course, requires records 
and accounting. Records are needed of machines, as to their 
installation, operation and maintenance. It is especially 
necessary that breakdowns and repairs shall be recorded, 
with regard to materials, a record of the purchases, issues 
and amounts consumed; as to work performed, both the 
quantity and quality. 

An authority 7 on this subject states that it is impossible to 
maintain either standards or records, unless they are tied 
into the cost accounting. 

Standards serve to develop a predetermined cost. Tak- 
ing into consideration the cost of material as determined by 
the standards of quantity and quality, the cost of labor as 
determined by the standard time of operation, the cost of 
the overhead as determined by the standard of the various 
elements composing it, it is possible to predetermine or ob- 
tain an estimated cost which may be used as a standard or 
basic cost and which provides for 100% efficiency. 



87 



CHAPTER XVIII 

Reconciling Predetermined and Estimated Costs 
With Actual Costs 

As a matter of fact, experience shows that there is fre- 
quently a wide difference between the ideal or standard and 
the actual. What should be is one thing, and what has been 
is another. Broadly speaking, it may be said that standards 
cannot be maintained. Failure to maintain them is due to — 
i. Inefficient material — material which is below the 
standard of quality and requires more than 
standard of quantity. 
2. Inefficient labor, due to inefficient workmen, 
methods or conditions. 
Cost accounting is required because of inefficiency. It 
is the duty of the efficiency engineer to say what the cost 
should be. It is the duty of the cost accountant to say what 
the cost has been. 

At this point a solution of the problem as to how a 
reconciliation may be effected between predetermined costs 
or estimated costs on the one hand and actual costs on the 
other, presents itself. 

Predetermined costs should be technically distinguished 
from estimated costs, in that they are constructed from pre- 
determined standards scientifically obtained, whereas esti- 
mated costs are purely hypothetical and are founded on the 
assumption that the costs for the current period will be the 
same as those of the next preceding period. 

88 



Reconciling Predetermined With Actual Costs 

As an illustration of the reconciliation between estimated 
cost and actual cost, attention is invited to the facts contained 
in the following tabulation : 

Total Material Labor Overhead 

Job No. 1 $3,080 $1,200 $1,600 $280 

" 2 2,200 1,000 1,000 200 



$5,280 $2,200 $2,600 $480 



The application of the principle to contract work, with 
which everyone is more or less familiar, will perhaps serve 
to make the illustration clearer. It should be noted that the 
accounts which we are about to reconcile are those contained 
in the general ledger, and the question before us is : how we 
may carry in the general ledger estimated or predetermined 
costs, without interfering with the actual costs as developed 
by the financial accounts, and at the same time bring them 
into agreement at the end of the period. This is accom- 
plished, so far as the estimated costs are concerned, through 
the medium of two accounts, namely: 

Cost of contracts; 

Reserve for cost of contracts. 

It is usually possible to obtain from a contract book, 
wherein the estimates of the jobs are listed, a total of the 
entire estimated cost for all jobs during the period. From 
these figures, which, in the case of the above tabulation, 
amount to $5,280, the following journal entry may be 
framed: 

Cost of contracts $5,280 

To Reserve for cost of contracts . . $5>28o 

Let us assume that at the end of the period the actual cost 
of the two contracts above mentioned is $5,780. This 

89 



Principles of Cost Accounting 

amount will have been charged to "Reserve for cost of con- 
tracts" concurrently with the credits to material, labor and 
overhead. By reference to the following ledger accounts it 
will be seen that the account "Reserve for cost of contracts" 
would at this point show a debit of $5,780 and a credit of 
$5,280, and the difference between the two sides of the ac- 
count would indicate the extent to which the estimate was in- 
correct. 

Dr. Cost of Contracts Cr. Reserve for Cost of Contracts 



Estimated... $5,280 
Reserve 500 



$5,780 I $5,280 
500 



In order to effect the reconciliation, which will close out the 
"Reserve for cost of contracts" and make the "Cost of con- 
tracts account" show the actual cost, a second journal entry 
in the amount of $500 is necessary. 

Cost of contracts $500 

To Reserve for cost of contracts $500 

The matter of reconciliation would be comparatively 
simple if the question of uncompleted contracts were not in-, 
volved. This difficulty may be overcome by treating the un- 
completed contracts as inventories in the case of both ac- 
counts involved, and proceeding as before. The above 
method of handling these accounts becomes more valuable 
when the principles applied to the cost in total are applied 
to the elements making up the cost. Under such circum- 
stances the journal entry for placing the estimated cost on 
the books would be as follows : 

Estimated cost of uncompleted contracts $5,280 

To Reserve for material, uncompleted contracts 2,200 

" labor, " " 2,600 

" overhead, " " 480 

90 



Reconciling Predetermined With Actual Costs 

Assuming that at the end of the period job No. i is com- 
pleted and job No. 2 uncompleted, the proper steps are, first, 
to deduct the items involved in the above journal entry af- 
fecting job No. 2 and bring them down as inventories. As- 
suming further that the total actual cost of job No. 1 is 
$3,280, distributed as follows: 

Material $1,200 

Labor 1,600 

Overhead 480 

the proper journal entry would be : 

Reserve for material, uncompleted contracts $1,200 

" labor, " " 1,600 

" overhead, " " 480 

To Material labor and overhead $3,280 

It will then be apparent that by posting the above journal 
entries to the proper ledger accounts that, as to the material 
and labor in job No. 1, both have been correctly estimated, 
but that the overhead has been underestimated in the 
amount of $200. The proper journal entry for effecting the 
reconciliation is as follows: 

Cost of contracts $3,280 

To estimated cost of uncompleted contracts $3,080 

Reserve for overhead, uncompleted contracts.. . 200 

A further illustration of the application of these principles 
will be found in the following tabulations and journal en- 
tries. The journal entries may be used in cases where, in 
the absence of a cost system, it is desired to point out to a 
client engaged in contracting the measure of inaccuracy on 
the part of his estimating department. 

9i 



Principles of Cost Accounting 

No. 1 $10,000 1 Estimated cost 

" 2 20,000 I of 

" 3 25,125 various contracts. 



$55,125 

FIGURES SHOWN BY GENERAL BOOKS 

12/31/08 Purchases 12/31/09 Cost 

Inventory, material. $3,000 $25,000 $2,000 $26,000 

uncompleted jobs.... 15,000 14,000 1,000 

Labor 18,000 18,000 



$45,000 
Overhead, various items 13,500 



Actual cost $58,500 

Cost of contracts (estimated) $55,125 

To Reserve for cost of contracts $55,125 

Reserve for cost of contracts 58,500 

To Material, labor, etc 58,500 

Cost of contracts 3,375 

To Reserve for cost of contracts 3,375 



92 



CHAPTER XIX 

The Report of the Cost Department 

It will be remembered that at the beginning of the first 
chapter it was proposed to discuss three topics. These topics 
embraced the nature of the information being sought, the 
means of obtaining the information, and the use to which 
the information is to be put after it has been obtained. The 
first topic was covered by an inquiry into the objects in as- 
certaining costs and which, briefly summarized, are to make 
them serve as a basis for fixing selling prices and to furnish 
information to the proprietor or administrative officer which 
will be of help to him in deciding upon administrative poli- 
cies. Such policies may include determining which lines of 
production or merchandise are profitable, and which are un- 
profitable, and instituting methods which will reduce costs. 
A discussion of the means of obtaining the information 
would appear to have been covered by reference to the sys- 
tem employed for gathering the information, and there re- 
mains to be explained the use to which the information is 
to be put after it has been obtained. 

Obviously, the party in interest is the proprietor or ad- 
ministrative officer. The information which he seeks is that 
which will enable him to draw quickly a conclusion from cer- 
tain facts presented to him concerning the costs. As a rule 
he is not a man whose time and patience will permit of delv- 
ing through voluminous books and records for this informa- 
tion. It must be summarized and placed before him so that 

93 



Principles of Cost Accounting 

its full significance will be evident at a glance. The medium 
for presenting the information in such summary form is the 
cost sheet, or the report of the cost department. The con- 
struction of the cost sheet will depend largely upon the 
nature of the information desired by the proprietor. 

Regardless, however, of circumstances, it is always es- 
sentially a statistical report and is based on unit costs. The 
units will vary, in some cases dozens, in others tons, in others 
single units, and in still others the unit may be the contract 
or job. Depending upon the use to which the information 
is to be put, the cost sheet may be compiled on a production 
or on a sales basis. The amount of detail which it carries 
will depend upon the extent to which the administrative offi- 
cer uses it as an index to operating efficiency. Generally 
speaking, the cost sheet must show distinctly with regard 
to unit costs the material, labor, and the overhead. In order 
to show the relation of the various elements of the material 
cost to the total material cost, it may sometimes be neces- 
sary to present in classified form all the materials involved. 
Such an arrangement is admirably adapted to comparison. 
At times it may be interesting for administrative and com- 
parative purposes to show the various labor departments 
separately. The proprietor may also be interested in know- 
ing all the items which make up the overhead. 

For the purpose of fixing a selling price and the super- 
vision of operations, a cost sheet on a production basis, 
that is to say, one showing the unit cost of finished goods 
orders, is usually sufficient. If it is the desire of the manage- 
ment to ascertain the profit on various contracts, or various 
orders, a cost sheet showing this information is very much 
more difficult of accomplishment and much more complex. 
The difficulty lies in that a shipping order may comprise 

94 



The Report of the Cost Department 

various qualities, or classes of goods coming from various 
production or finished goods orders wherein the cost varies, 
and it becomes necessary to assemble the unit cost of the 
various finished goods orders in order that the total cost 
of the shipping order may be ascertained for comparison 
with the sales price to show the profit on the order in ques- 
tion. 

The general arrangement of the cost sheet is illustrated 
in a form to be found on page 96. It is presented in the 
simplest possible form in order that the principles under- 
lying its construction may be readily seen. 



95 



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[the end] 



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